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HEALTH SAVINGS accounts (HSAs) were introduced in 2003, and have since become commonplace in employee benefit plans. My experience with HSAs dates to 2004, when my employer offered $400 in one-time seed money as an incentive to sign up.
HSAs differed from existing health-care flexible spending accounts, and offered some features I preferred. To me, the HSA’s most appealing feature was that I controlled the money. There’s no “use it or lose it” rule, as there is with flexible spending accounts. Unspent money could accumulate and continue growing year after year.
I also liked HSA’s triple tax advantage. There was no tax owed on my contributions, no tax on my investment earnings and no tax owed on withdrawals for qualified health-care expenses. This made my HSA even more tax advantageous than, say, Roth contributions to my 401(k), because the latter didn’t earn me an immediate tax-deduction.
My family members were all in good health when I signed up for a high-deductible health plan, which made me eligible to open an HSA. I planned to pay for health-care bills out of pocket and let the HSA grow tax-free. By keeping receipts for the medical bills I’d paid, I could always reimburse myself from my HSA if I needed cash.
At first, my HSA money sat in a checking account. The administrator required a $3,000 minimum to invest in a limited choice of mutual funds, plus the funds had front-end loads. Not very appealing.
Eventually, the administrator provided better options. With my aggressive investing style and the maximum contributions that I made each year, my HSA balance has grown significantly. It also grew because I didn’t take withdrawals for a long period.
My plan to conserve my health savings account was tested in January 2010, when I suffered a heart attack. Ever the planner, I remember thinking on the way to the hospital that this would ruin my HSA. Later, I realized this is exactly why I had the account—for health care expenses. As it turned out, this was my only withdrawal for medical expenses before retirement.
When I retired in 2021, my HSA had a balance of almost $60,000. Since I couldn’t make any more contributions once I was enrolled in Medicare, it seemed prudent to change investment strategy. I focused on dividends and interest with an eye to earning more consistent returns. I wanted steady results to pay the premiums on my Medicare Part D drug insurance.
My plan worked fine until interest rates started rising, and the value of my bond funds fell. As the financier J.P. Morgan said of the market, “It will fluctuate.”
While my health care expenses in retirement have been slightly higher than I expected, I continue to pay many of these bills with money drawn from sources other than the HSA. This year, however, I relented. I paid my deductibles and coinsurance for foot surgery—plus a trip to the emergency room—from my HSA. I did so to avoid making taxable withdrawals from my traditional IRA.
I paid most of these bills with dividend distributions that I hadn’t reinvested back into the market. That turned out to be a prudent move during 2022’s bond fund downturn. My plan is to continue using my HSA for my Part D premiums and for larger medical expenses. What if I want to draw down the account faster? I always have the option to reimburse myself tax-free using that box of medical receipts that date back to 2004.
I do not have LTC insurance so I am holding on to my HSA account funds to pay those actual medical expenses when they occur.
A read a comment on, I believe, the a Humble Dollar from a dentist that he is saving his HSA funds for dental expenses as he has traditional Medicare, which is a plan I have decided to adopt. This is one of the many benefits of reading the HD.
My wife and I never had the opportunity to have an HSA until she retired early and ran off her COBRA coverage. I stayed on COBRA until I moved to Medicare/Medigap at 65. After my wife’s COBRA expired, I explored options for coverage to bridge her to 65, 2 years and 8 months away. A high deductible plan with an HSA appeared to be a good fit. I could only use a partial year funding (10/12 of $4850) in year one and will have 10/12 of the annual amount the last year. My wife has been paying for the OOP costs of medical and dental care along the way. We don’t anticipate having a significant balance to carryover into her Medicare years. In the meantime, the contributions are tax deductible. I keep the cash in a money market account as this is a short term exposure. The interest is not taxed.
Harold, I don’t understand your numbers. You mentioned $4,850 was 10/12ths of the initial calendar year maximum. But, that doesn’t match any of the annual maximums in 2023 or prior years. More importantly, did you consider the December 1st rule for the first year? And, even though you were enrolled in Medicare, did she enroll in family coverage so she could contribute up to the family maximum plus the catch-up? And, of course, monies in her HSA qualify to reimburse your Medicare Part B and Part D premiums. Finally, be careful about the effective date of Medicare Part A coverage which is sometimes backdated six months and how that affects HSA contribution eligibility.
If you’re 50-plus, you can contribute $4,850 to an HSA in 2023, thanks to the $1,000 catch-up contribution.
Mark, thanks for this article. HSAs are indeed a tax “triple-threat” and I’m thankful for ours. And I admire your fiscal discipline—thinking about your HSA while en route to the hospital after a heart attack!
I have a couple of questions and maybe Bill Perry will see them and weigh in:
1) Why are Part D drug plan premiums a Qualified Medical Expense (QME) for HSAs, but not medigap plan premiums?
2) On your 1040 for the year when you used HSA funds to pay for QMEs, will the IRS send you a “letter audit” asking you to provide documentation of those expenses? I ask because long ago, when I used 529 funds to pay eligible expenses during our kids’ college days, there was no place on the 1040 to describe or document those. Much later I received letter audits and spent long hours putting together all the documentation for the IRS.
Good questions.
I agree with the article author and my fellow retired CPA Mark on point 1. When HSAs first came into being the IRS issued Notice 2004-50 in question and answer format which reads in part as follows –
Q-45. If a retiree who is enrolled in Medicare receives a distribution from an HSA to reimburse the retiree’s Medicare premiums, is the reimbursement a qualified medical
expense under section 223(d)(2)?
A-45. Yes. Where premiums for Medicare are deducted from Social Security benefit payments, an HSA distribution to reimburse the Medicare beneficiary equal to the
Medicare premium deduction is a qualified medical expense
I also agree with Mark on point 2 that proper documentation is vital to support the tax free distribution of qualified medical expenses. I like to gather the supporting documentation prior to filing my return and my personal preference is when I plan to distribute a medical reimbursement from my HSA to do so late in the year with a single distribution. I have already built my supporting documentation before I make any distribution. It is incumbent on the taxpayer to assemble and retain such supporting documentation. I recommend you save yourself from paying professional time rates and have a simple reimbursement method in the event of a future tax authority inquiry. Keep the support until the statute of limitation expires on your tax return for the tax year of distribution.
My expectation is that if you are receiving an inquiry letter from the IRS (computer) regarding documentation of the total of your HSA distributions that the IRS letter was caused by the absolute amount of the dollar distribution you reported on your form (2022) 8889 line 15 being above a certain dollar amount or so many standard deviations above the IRS expected or average HSA distribution amount based on your income . I am not aware of the IRS sharing the criteria on how they pick those to whom they send such inquiries. A human will deal with your reply so make your reply organized to encourage the IRS representative to move on to the next lucky taxpayer.
A recent 2023 article in the Journal of Accountancy regarding HSAs was worth the reading time for me.
https://www.journalofaccountancy.com/news/2023/jan/9-facts-hsa-that-might-surprise-your-clients.html
Best, Bill
I believe HSA funds can also be used for paying LTC insurance plan premiums if it’s a tax qualified plan. There is an annual amount limit (per person) that can be withdrawn tax free based on age to pay for LTC premiums, but it’s fairly generous. This is a pretty easy way to withdraw fairly sizable amounts without having to track a lot of receipts. I don’t know if this is allowed for hybrid plans.
I think you mean “qualified long-term care insurance” (not necessarily part of a tax-qualified benefit plan) per Internal Revenue Code 7702B. Myself and my spouse, we are accumulating HSA assets and will use them to pay any LTC expenses that qualify under Internal Revenue Code 213(d)(1)(C) – which refers you back to Internal Revenue Code 7702B(c).
You are the poster child for the HSA. You’ve done it perfectly.
HSAs can be a fine tool, but when workers are forced into a HDHP they create financial stress for those workers who are not upper middle class income wise. They simply cannot afford to fund them and pay out of pocket for the large deductible while trying to accumulate in the HSA. It is virtually impossible.
Once on Medicare ongoing out of pocket costs like deductibles and co-pays should be covered by Medigap insurance. An HSA is valuable for dental, vision and prescription costs at that point.
But as I said, the HDHP/HSA promoted by employers does little financially and can be harmful for the more average worker. Even when the HDHP is an option, the alternative plan premiums become a burden.
Most workers who have traditional PPO coverage are over-insured as the median out of pocket medical spend in America continues to be < $500 per person.
Worse, where the HSA-qualifying health option is offered as a choice, too many employers/plan sponsors mislead workers by identifying the HSA option by its deductible, e.g., the $1,500 plan. This places inordinate emphasis on the deductible – and likely ignores the lower level of monthly employee contributions which are usually taken on a pre-tax basis via a cafeteria plan.
Even worse, the comparison should be the differential between deductibles as most PPO options have their own deductible.
That is, when offered as a choice of coverage, the HSA-qualifying health option (properly priced coupled with an employer HSA contribution) is often the better choice for most American workers – because:
And, if we are lucky enough to avoid significant medical expense, HSA savings are better for retirement preparation than saving in a 401k because they receive better tax preferences (pre-tax for FITW, SITW, FICA and FICA-Med when contributed and potentially when used after age 65 to pay for Medicare premiums and qualifying out of pocket expenses). Further, HSAs can meet a variety of needs beyond reimbursing certain medical and LTC premiums and out of pocket medical, dental, vision, hearing and long term care expenses. HSAs monies can also provide an income in retirement and survivor benefits.
Fact is, plan sponsors who fail to offer HSA-qualifying coverage are denying their workers access to America’s most tax-favored benefit.
Unfortunately, I am “that guy” who installed HDHPs at two separate employers and froze pensions.
While I agree the introduction of HDHP can be a financial problem for some employees, that can be eased with seed money each year in the HSA and keeping a traditional medical program at the introduction, and a full education program on the merits of both plans, not a full replacement.
No matter what medical plan is implemented, it will not be adequate for some workers. Where management wants to draw that line will always be a challenge.
HSAs are most advantageous for upper income people who are healthy, which fortunately describes my wife and I
At retirement I rolled my HSA into a Fidelity HSA. It has more investment options. Plus, my employer’s HSA had fees per trade. As soon as my contributions stopped, the old plan started charging a monthly maintenance fee.
I’m not a CPA. I’ve read that we can save our receipts for medical expenses for years. In the event of a withdrawal someday, you or your heirs can use the old receipts to show it was to reimburse medical expenses. I understand that it applies even though you already paid those expenses with non-HSA funds.
Again, I’m not an authority on the subject (for once lol). I’d be interested in what others think of this.
This is something I will cover with my CPA next year. In the meantime, I’ve been retaining those receipts.
Correct. Just keep in mind (and remember to document) the day you opened your first HSA – only qualifying expenses incurred after that date qualify for tax favored reimbursement.
You are correct, you can reimburse yourself at any time in your lifetime, with proper documentation, and you did not previously deduct them. That’s where the receipts become important. That shoebox full of receipts is valuable. And I was a CPA until I retired.
Section 223(f)(8)(B) has some bad news for an individual, other than the surviving spouse, inheriting an HSA. Sure, they get the assets in the HSA. But, (i) the account loses its status as an HSA, and (ii) even worse, the entire amount of the HSA is included in the recipient’s taxable income in the year of the original owner’s death.
This is the hidden HSA death tax.
https://fitaxguy.com/inherited-health-savings-accounts/
I recommend that anyone with a HSA read the 2022 IRS Pub 969 which will address most of the questions regarding how a HSA currently functions.
https://www.irs.gov/pub/irs-pdf/p969.pdf
Also you can do rollovers while still in an employer plan, just not more often than once per year. And if your child is on your HDHP and files his own taxes, he can contribute to his own HSA (at Fidelity or the like) at the family level. See the Finance Buff blog for good posts on these topics.
Where is the “not more than once a year” rule? Perhaps because I “transfer” money, that is different than what you are talking about? I do it whenever I think of it, which is usually once the balance gets to $1500 or so, I transfer it to Fidelity, which has lower fees and better investing options.
From publication 969:
Rollovers
A rollover contribution isn’t included in your income, isn’t deductible, and doesn’t reduce your contribution limit.
Archer MSAs and other HSAs. You can roll over amounts from Archer MSAs and other HSAs into an HSA. You don’t have to be an eligible individual to make a rollover contribution from your existing HSA to a new HSA. Rollover contributions don’t need to be in cash. Rollovers aren’t subject to the annual contribution limits.
You must roll over the amount within 60 days after the date of receipt. You can make only one rollover contribution to an HSA during a 1-year period.
Note. If you instruct the trustee of your HSA to transfer funds directly to the trustee of another of your HSAs, the transfer isn’t considered a rollover. There is no limit on the number of these transfers. Don’t include the amount transferred in income, deduct it as a contribution, or include it as a distribution on Form 8889.
It should be in the IRS publication William references.
Yes, you can reimburse yourself for old receipts as long as you have not taken a deduction on your taxes.