Is a Health Savings Account (HSA) a Good Idea? 

November 14, 2023

There are several benefits to having a Health Savings Account (HSA) and with the rising cost of healthcare, it might be a good time to think about starting one, if you haven’t already. 

What is a health savings account and who is eligible?   

In brief, an HSA is a medical savings account to which you can contribute pre-tax funds (at the time of deposit), thereby lowering your tax burden. This makes the HSA a tax-favorable way to save for healthcare while simultaneously reducing your tax liability. 

Not everyone is eligible for an HSA, though. In order to sign up, you must be covered by a “high deductible health plan.” In 2023, this is defined as $1,500 deductible for individuals, or $3,000 for families. (This increases to $1,600 and $3,200 in 2024, respectively.) However, an individual (and the individual’s covered spouse) who has reached age 55 before the close of the year, and is an eligible HSA contributor, may make additional “catch-up” contributions for 2023 and 2024 of up to $1,000 per year. Additionally, an HSA may be established by any eligible individual, or done so on their behalf. 

Furthermore, regardless of when you sign up during the year, taxpayers who are eligible individuals on the first day of the last month of the tax year are treated as having been eligible individuals for the entire year for purposes of computing the annual HSA contribution. This means you can start your HSA now and reap these tax-free benefits for 2023. 

What are the benefits of having an HSA? 

There are many benefits to establishing an HSA, including: 

  • Contributions made by the individual to the HSA are tax deductible (limits apply) 
  • Earnings on the HSA are not taxable 
  • Employer contributions to the HSA aren’t taxed to the employee 
  • Distributions made from the HSA to the individual for covered medical expenses are not taxable. 

As an added bonus, for one time only, taxpayers can withdraw funds from an IRA and transfer them tax-free to an HSA. This means that the amount transferred is a) excluded from gross income, and b) not subject to an early withdrawal penalty, typically 10%. A transfer of this type is subject to the maximum allowed HSA deductible in effect at the time of the transfer. 

Perhaps even more importantly, any unused HSA funds can roll over from year to year, unlike most Flexible Spending Accounts (FSA). This feature gives the account holder additional flexibility and future security as healthcare costs continue to rise. Plus, HSA funds can be used to cover qualified medical expenses of the individual as well as any covered spouse or dependents. This makes the HSA a valuable tool in your tax-planning toolbox. 

Deductions, distributions, and qualified medical expenses 

HSA contributions can be deducted, but there are limits. The 2023 limit on deductible contributions is $3,850 for individuals and $7,750 for families. In 2024, these amounts are increasing to $4,150 and $8,300, respectively. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits for 2023 can’t exceed $7,500 for individual coverage or $15,000 for family coverage ($8,050 and $16,100 for 2024). 

Additionally, there are also specific requirements for HSA distributions as they must be made for “qualified medical expenses.” Qualified medical expenses generally means those that would qualify for the medical expense itemized deduction. If funds are withdrawn from the HSA for other reasons, the withdrawal becomes taxable and subject to a 20% tax penalty. The penalty is waived if distributions from the account are made after reaching age 65 or in the event of death or disability. 

What happens to your HSA if you are no longer eligible? 

Once HSA eligibility changes, such as for someone enrolling in Medicare, the HSA account and the tax-free benefits remain intact as long as the funds in the account are being used for qualified medical expenses. 

As you can see, it’s worth looking into the HSA as it has numerous tax benefits for you and/or your family. To learn more about how to include an HSA in your tax-planning strategies, please reach out to your CJBS team member today. We are here to help. 

The CJBS Team