What If I told you you could:
- Save money pre-tax. You pay no income tax on the amount you saved,
- Your money grows tax-deferred. No taxes on the investment growth, and
- You can withdraw with normal income taxes. After age 65 you can withdraw funds for any reason and pay ordinary income tax.
You’d probably say I was pitching an IRA contribution. But the age requirement for withdrawals which avoid the 10% penalty is 59 and 1/2. So it’s not an IRA.
I’ll take it one step further. What if I said you could withdraw funds for qualified medical expenses in any year you incur them tax free! On top of that what if you never had any required distributions?
It all sounds too good to be true right? You just can’t do all of those things in an IRA. An IRA has Required Minimum Distributions starting by April 1st of the year after you turn 70.5. IRA withdrawals are always subject to taxes and possibly penalties, even if they’re taken for qualified medical expenses.
So what am I referring to? I’m referring to a Health Savings Account (but I call it a Medical IRA). It’s a lot like an IRA with no RMD’s and accessibility for medical expenses. Below are the specifics for Health Savings Accounts.
Do I qualify for a medical IRA?
To qualify for a Health Savings Account, you must:
- Be enrolled in a High Deductible Health Plan (HDHP). A HDHP has a higher annual deductible than a typical health plan, and a maximum limit on the sum of the annual deductible and out-of-pocket medical expenses that an enrollee must pay for covered expenses (these include co-payments and other amounts but not premiums).
To be considered a HDHP (for 2014), the minimum annual deductible and maximum annual deductible and other out of pocket expenses must meet the following guidelines:
|Self-Only HDHP Coverage||Family HDHP Coverage|
|Minimum Annual Deductible||$1,250||$2,500|
|Maximum Out-of-Pocket Expenses||$6,350||$12,700|
|*You should confirm with your health insurance company that your plan is an HDHP.|
Click here to read http://www.irs.gov/publications/p969/ar02.html for more detailed information.
In addition, you must:
- Not have other health insurance that isn’t an HDHP
- Not be enrolled in Medicare or Tricare
- Not have received care from the Veteran’s Administration within the last 13 months
- Not be eligible to be claimed as a dependent on someone else’s tax return
If you meet those guidelines for a High Deductible Health Plan, you qualify for a Health Savings Account with the following limits:
|Under age 55||Over age 55|
|Self-Only HDHP Coverage||$3,300||$4,300|
|Family HDHP Coverage||$6,550||$7,550|
|*Contributions are generally pro-rated for the months the individual is enrolled in an HDHP. Contributions can be made by the individual, the employer or anyone, but the annual contribution limit above applies. The contribution deadline is the client’s tax-filing deadline, not including extensions (i.e. April 15th).|
What are the tax advantages of the medical IRA?
- Control. The HSA is always owned and controlled by the individual, not the employer.
- Death of an HSA Owner. A spousal beneficiary is automatically treated as the HSA owner. Non-spouse beneficiaries must include the HSA value at death as taxable income, but there is no tax penalty (normally 20%).
- Distributions. Distributions are tax-free for qualified medical expenses of the individual, the spouse or any dependents. Distributions non used for qualified medical expenses are taxable as ordinary income with a 20% penalty unless they’re taken due to death, disability or the owner is older than age 65.
- Employee/Individual Contributions. Contributions are tax-deductible as an above-the-line deduction (which reduces your Adjusted Gross Income) regardless of an individual tax-filing status or income.
- Employer Contributions. Employer contributions are also tax-deductible and must be “comparable”. Employees do not include employer HSA contributions in income.
- Investment Gains. Gains are always tax-free if used for qualified medical expenses.
- Portability Between HSA’s. HSA funds can be rolled over or transferred to another HSA one time per 365 days and rollovers must be completed within 60 days after the date of receipt.
- Portability from an IRA. IRA funds cannot be rolled over or transferred into an HSA. There’s a one-time exception for a qualified HSA funding distribution.
- Qualified HSA Funding Distribution (QHFD) from an IRA. A QHFD is a tax-free direct transfer from an IRA to an HSA. It’s a one-time only transfer that’s limited to an individual maximum HSA contribution for the year. Only pre-tax IRA funds can be transferred (exception to the IRA pro-rata rule). Does not apply to ongoing SIMPLE or SEP IRAs. After a QFHD, an individual must remain HSA eligible for a 1-year testing period to avoid taxes and penalties.
- Use-It-Or-Lose-It-Rule. Does not apply. Unused HSA funds continue to belong to the owner.
- Long Term Care. HSA distributions can even be used to pay for Long Term Care Insurance tax and penalty free (however the amount is limited, see IRC 213(d)(10)).
- You can use your HSA to pay for medicare premiums (but not medigap coverage).
As you can see, HSA’s are extremely powerful! It’s like an IRA with a lot of extra bells and whistles that make it a great way to cover medical expenses AND save for retirement costs later in life. It’s also a great way to help cover medical expenses in that “gap” between retirement and Medicare coverage.