The Hitchhiker’s Guide to Health Savings Accounts (HSAs)

guide to HSA

The Health Savings Account (HSA) is the darling of the personal finance world. It struts and preens and shows off its triple tax advantages, much to the envy of the far less fancy IRAs and 401ks. The HSA is sexy, and it knows it. Today’s beast of a post, in FAQ format, covers everything you should ever need to know about HSAs.

What is an HSA?

The Health Savings Account is a tax advantaged medical savings account available to folks in the U.S. who:

  • Are enrolled in a High Deductible Health Plan (HDHP).
  • Are not enrolled in Medicare.
  • Cannot be claimed as a dependant on someone else’s tax return and
  • Have no other health coverage (excluding vision, dental, disability, accident, and long-term care) and are not covered by another plan (i.e. spouse’s employer plan).

How do I know if my plan qualifies as an HDHP?

Your plan needs to meet certain minimum deductible and maximum out-of-pocket criteria to qualify as an HDHP. The current minimums and maximums are documented in a nice table in this Wikipedia article. The IRS may update the numbers every year, so always check for the latest numbers.

What is the triple tax advantage of an HSA?

  1. You contribute your pre-tax money to an HSA (much like a 401k contribution). The icing on the cake is that not only are your contributions exempt from federal income tax, they are also exempt from the Federal Insurance Contributions Act (FICA) tax, an advantage afforded to no other retirement savings account.
  2. Once the money is in your HSA, you can invest it in stocks and bonds, and it grows unmolested by taxes.
  3. If you withdraw money from this account to pay for a qualified medical expense, that withdrawal is not subject to taxes either.

These are dollars that you could never pay taxes on, ever. If that isn’t a magical thing, I don’t know what is.

The Mad Fientist calls the HSA the Ultimate Retirement Account, and in this classic article about HSAs he explains the triple tax advantage much better than I ever could, and with a gorgeous infographic to boot.

Are my HSA contributions exempt from state taxes?

 

Not always.

A few states still tax contributions to HSAs, and they will also tax any earnings generated by the money invested in your HSA. The states that tax HSA contributions and earnings are:

  • California
  • Alabama and
  • New Jersey

You can read more about state taxation of HSAs on the Bogleheads wiki page.

How much can I contribute to an HSA in a given year?

The limits depend on the kind of coverage you have via your HDHP. For 2017:

If you have individual coverage: $3400
If you have family coverage: $6750

If you are 55 or older you can make an additional $1000 catch-up contribution.

The limits are set by the IRS and may be updated every year. There are no income limits associated with contributing to an HSA.

If your employer contributes anything to your HSA, that counts towards the annual contribution limit. In this respect the HSA is different from a 401k, where an employer’s contributions to not count towards your $18,000 annual limit.

You have until the tax filing deadline of the following year to make allowable contributions to your HSA.

 

What can I use the money in my HSA for?

Here are some links that list what constitutes qualified medical expenses that you can pay for using money in your HSA:

You typically cannot use your HSA dollars to pay your health insurance premiums. A few exceptions exist:

  1. Long term care premiums.
  2. COBRA premiums.
  3. Health insurance premiums for folks receiving unemployment benefits.
  4. If you are 65 or older you can pay for health insurance premiums other than Medicare supplemental policies.

guide to HSA

Does the money in my HSA rollover from year to year?

Yes. Unlike a Flexible Spending Account (FSA) there is no deadline associated with spending the money in your HSA; no use it or lose it. The balance simply rolls over from year to year and keeps accumulating.

 

Can I withdraw from my HSA for non-medical expenses?

Yes, but you will pay a penalty, unless you are 65 and older.

Any funds that you withdraw from your HSA and do not use for a qualified medical expense will be taxed at your income tax rate, plus a hefty 20% tax penalty.

Once you are 65 or older withdrawing from your HSA is the same as withdrawing from a traditional IRA; you only pay income tax.

You will also be exempt from the penalty if you become disabled.

 

When can I reimburse myself from my HSA for qualified expenses?

 

Whenever you want.

You can reimburse yourself when you incur the expense, or any time after. e.g. you could incur a qualifying medical expense when you are 32 years old. You could choose to pay out of pocket, and then reimburse yourself when you are 60 years old.

Why wait to reimburse yourself? Because if you have invested the money in your HSA, you want to take advantage of the power of compounding. Instead of withdrawing $100 today, why not let the $100 grow to a $1000 (tax free of course!) and then withdraw the $100?

 

What proof do you need to withdraw from your HSA without incurring a penalty?

When you make a withdrawal from your HSA, you don’t actually have to submit any proof to the IRS. You have to fill out the requisite forms, but you don’t need to submit any receipts. The proof is only required if the IRS chooses to audit you.

 

Here is what I do:

I keep one folder per year in the cloud into which I dump scanned copies of:

  • The Explanation of Benefits (EOB) from my insurance company
  • Bills from hospitals, doctors etc.
  • Credit card statements

In addition to this I maintain a Google Sheet with the following fields:

  • Date paid
  • Bill name. This is the name of the file(s) that I uploaded in the folder mentioned above that correspond to this bill.
  • Patient name
  • Bill Amount
  • Amount paid by insurance
  • Amount I paid
  • Method of payment. If I paid via credit card, I’ll have the scanned statement as mentioned above. If I paid via cheque, I’ll note the cheque number here.
  • Notes. Anything special I want to note about the expense.

 

What are the tax forms that are associated with taking an HSA distribution?

Your HSA provider will report every distribution to the IRS via a Form 1099-SA. They will send you a copy of this form.

Your HSA provider will also generate a Form 5498-SA that documents your total contributions for the year.  

You will need both of these forms to help you to prepare Form 8889 and attach it to your tax return when you take a distribution from an HSA.

 

What if I accidentally contribute too much to my HSA?

If you realize that you have gone over the annual contribution limits for your HSA, and you realize this before the tax filing deadline for the year in April, you can remedy the situation and avoid any penalties.

You will need to

  • Withdraw the excess contributions from your account.
  • If your excess contributions have grown because you invested them, you also have to remove any earnings from your account. Since it is hard to figure out exactly what growth to attribute to your excess contributions, the IRS permits you to make a determination of the average gains of your HSA investments during that time, and then attribute a pro rata share of those average gains to those excess contributions.
  • Inform your HSA custodian of the mistake.
  • Include the excess contributions (and any income) on your tax form as ‘other income’ and pay the tax due on them.

 

The reason that you need to inform your HSA custodian of the mistake is so that they can generate the appropriate forms for tax purposes. They will need to generate a 1099-SA with a distribution code of ‘2’ that tells the IRS that this distribution was not for qualified medical expenses, but to correct excess contributions and they will also need to correct the 5498-SA form to not include your excess contributions.

If you don’t withdraw any excess contributions by tax day, you will be charged a 6% penalty on the excess amount for every year that the amount stays in your account undeclared.

This article covers what you should do if you don’t remove excess contributions by tax filing date.

 

What can I invest the money in my HSA in?

What you can invest in is determined by your HSA custodian (i.e. the bank with which you hold your HSA). My HSA is with healthequity.com and I have access to a variety of low expense ratio Vanguard funds.

Most HSA custodians will require you to maintain a certain minimum balance in uninvested cash in your account, and will allow you to invest amounts that are above that minimum balance. My HSA e.g. requires a $500 minimum balance.

 

Who chooses the HSA custodian?

Typically, your employer will choose an HSA custodian to work with. If you sign up for an HSA, then your HSA contributions will be deducted from your paycheck and deposited in your HSA.

You are not limited to the HSA custodian that your employer chooses. More about that below.

 

What should I know about my HSA custodian?

As with any other financial institution always pay attention to the fee schedule of your HSA custodian. Here are some things to look out for:

  • Is there an annual maintenance fee?
  • Is there a minimum balance you can maintain to waive this fee?
  • Do they charge a fee per transaction?
  • Do they charge a % of your investment portfolio over and above the expense ratio of the funds you are invested in?

For example, click here for HSA Savings Administrator’s fee schedule. They have an annual administration fee of $45 and charge a custodial fee of 6.25 basis points per quarter (or $0.625 per $1000 every three months).

Some HSA custodians will offer you a debit card linked to your HSA, and you can use that debit card to pay for your medical expenses. Others will only allow you to write cheques against the account. Some allow you to pay medical bills online through a portal on their site.

guide to HSA

Can I use a different HSA custodian than the one chosen by my employer?

If your employer has teamed up with an expensive HSA custodian, or one with poor investment choices, all is not lost. You are free to open an HSA with any HSA custodian you like. Your employer may or may not agree to send your payroll deductions to another HSA custodian. If your employer will not allow payroll deductions to your HSA custodian of choice, you can still open your HSA wherever you like, contribute your after-tax dollars to it up to the maximum for the year and then claim the tax deduction when you file your taxes for the year. In other words – nearly the same tax benefits apply, you just don’t realize those benefits until you file your taxes. According to IRS publication 969 you can claim a tax deduction for contributions made to your HSA even if you don’t itemize your deductions.

Why did I say that nearly the same tax benefits apply? Remember that HSA contributions made via payroll deductions are exempt from FICA taxes. You can’t claim a reimbursement of your FICA taxes paid on your tax return. 7.65% of $6750 (the maximum contribution) is $516. You will have to determine if the lower fees and/or better investment choices at your chosen HSA custodian are enough to offset this loss.

 

Is there a list of HSA custodians with reviews and recommendations?

 

Can I transfer my HSA from one bank to another?

Yes, you can. According to this IRS source you can either perform a rollover or a trustee-to-trustee transfer.

The IRS defines a rollover as a tax-free distribution to the taxpayer of cash or other assets from one HSA that the taxpayer contributes to another HSA. In other words, you withdraw the money from your account at the first HSA provider, and then deposit it with the second HSA provider. A rollover from HSA-to-HSA does not count towards your annual contribution limit, and is not a taxable event. You can do a rollover only once every 12 months (the clock starts when you do your rollover). Once you withdraw your money from your HSA you have 60 days to deposit it into another HSA.

A trustee-to-trustee transfer is not considered a rollover. This is a direct transfer from one bank to another. It is not subject to the once in 12 months rule, and does not have to be reported on your tax forms. The disadvantage? Most banks charge a transfer fee. The rollover, on the other hand, can be done for free.

The Finance Buff has a most excellent resource detailing how to complete a rollover from HSA-to-HSA.

 

What happens if I enroll in a qualifying HDHP and open an HSA in the middle of the year?

If you open an HSA before the first day of December, you can contribute the total allowable amount for that year. To take advantage of the tax savings, however, you must meet the following testing conditions:

  • Stay enrolled in a qualifying HDHP for the following 12 months.
  • Not have other health care coverage that would make you ineligible to contribute to an HSA

If you don’t meet the conditions, then, according to IRS publication 969:

“If you fail to remain an eligible individual during the testing period, for reasons other than death or becoming disabled, you will have to include in income the total contributions made to your HSA that wouldn’t have been made except for the last-month rule. You include this amount in your income in the year in which you fail to be an eligible individual. This amount is also subject to a 10% additional tax. The income and additional tax are calculated on Form 8889, Part III”

Is my HSA subject to RMDs?

No, your HSA is not subject to Required Minimum Distributions (RMDs).

 

Can I rollover from an IRA to an HSA?

Funny you should ask. Why yes, yes you can. Once in your lifetime you are allowed to fund your HSA using money from either a traditional or a Roth IRA. The amount of the distribution from your IRA must be less than or equal to your maximum contribution limit for the HSA.

IRS notice 2008-51 has all the juicy details and some helpful examples.


Readers, what did I miss? If you can think of anything to do with HSAs that should be in this guide, but is not, do let me know. And of course, if I’ve got anything wrong, holler.

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5 thoughts on “The Hitchhiker’s Guide to Health Savings Accounts (HSAs)”

  1. Very thorough list of all the frequent (and infrequent) questions you can think of regarding HSAs! We are BIG fans of the HSA for many of the reasons you highlighted above. I mean, we are all going to have health care expenses in retirement, right? The HSA is the best way to save for those future expenses and provides a great deal of flexibility to the retiree.

    There are some hidden downsides to them, however, and I should have a post about these issues coming soon. I will certainly link back to your very comprehensive summary here!

    1. You, Mrs. Need2save, are such a tease. I look forward to reading all obout the hidden downsides when you publish!

  2. HSAs are strangely magical! I learned about them from the Mad Fientist, shortly after my work offered them! I signed up and have been investing the maximum for almost 3 years in low cost Vanguard index funds. What a great savings vehicle! Thanks for the great summary of it!

    1. Nicely done! I hope the maximum does go up soon, as is being touted in the plans proposed by this administration – it is the one good thing that may come out of that piece of legislation.

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