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Beyond Investments- Health Savings Accounts

Published by: Jeff Hall, CFP®,CIMA® Date: June 05, 2020

It’s hard to believe, but Health Savings Accounts (HSAs) have been around for almost 17 years. HSA’s were introduced in the Medicare Modernization Act, which was signed into law in December 2003 by President George W. Bush. The goal was to encourage individuals to enroll in High-Deductible Health Plans (HDHP) to reduce healthcare spending through more conscientious healthcare decisions. In return for having health insurance coverage with a higher deductible, taxpayers can enjoy the triple tax benefit of funding an HSA (tax-deductible contributions regardless of income, tax-deferred growth and tax-free withdrawals for qualified medical expenses). For those that can afford the higher deductible and who can leave the funds intact, the HSA can be an excellent way to accumulate savings that can be distributed tax-free to pay for ever-increasing healthcare costs, especially in those years where work is optional. Still, healthcare costs are likely to be a significant expense.

Though there are plenty of reasons to accumulate money inside an HSA to help with future spending goals, there are times when there is minimal cash flow margin to meet monthly expenses, including healthcare costs. For those that find themselves in such a circumstance and need to make the most of their HSA, there is a lesser-known benefit of having an HSA called a Qualified HSA Funding Distribution (QHFD). A QHFD is a once-in-a-lifetime distribution from a taxpayers IRA to their HSA. The amount that may be transferred is limited to the maximum contribution amount to an HSA for the year in which the distribution is made ($3,550 for an individual and $7,100 for a family with a $1,000 catch up contribution for taxpayers 55 and older). Once the money has been transferred to the HSA, the funds can be distributed tax-free to pay for qualified medical expenses.

According to IRS Publication 502, the following list is a general summary of which medical expenses can be deducted:

  • Payments to doctors, dentists, surgeons, chiropractors, psychiatrists, psychologists, and other medical practitioners
  • Hospital and nursing home care
  • Acupuncture
  • Addiction programs, including for quitting smoking
  • Weight-loss programs for doctor-diagnosed diseases, including obesity (but diet food and health club dues usually don’t count)
  • Insulin and prescription drugs
  • Admission and transportation to medical conferences about diseases that you, your spouse or your dependents have (but meals and lodging don’t count)
  • Dentures, reading or prescription eyeglasses, contacts, hearing aids, crutches, wheelchairs and service animals
  • Transportation costs to and from medical care
  • Insurance premiums for medical care or long-term care insurance if they’re not paid by your employer, and you pay out of pocket after taxes

A distribution from an IRA could be used to cover the costs. The distribution would be taxable (and possibly subject to penalties), and only medical expenses above 7.5% of adjusted gross income can be deducted. Furthermore, deductible medical expenses have to be itemized on Schedule A, and with a $24,800 standard deduction for a married couple in 2020 ($12,400 for an individual), total itemized deductions would have to be significant for most taxpayers before itemizing would make sense.

For those folks that find themselves unable to make an annual contribution to their HSA and want to continue maximizing the long-term, tax-free benefits of an HSA, a contribution via a Qualified HSA Funding Distribution would make sense due to the tax-preference hierarchy of an HSA over a traditional IRA.

If you have any questions or would like to discuss in further detail we’re here to help.