HSAs: A Great Tax-Saving Opportunity

Posted on Monday, May 13, 2019

Health Savings Accounts (HSAs) are gaining popularity. These accounts were originally created in 2003, to provide tax-favored coverage for individuals with high-deductible plans. Later HSAs got a facelift when a law was passed which made these accounts even more beneficial. Thanks to the Tax Relief and Health Care Act of 2006, HSA participants are now allowed greater deductible contributions and can make tax-free rollovers from other types of accounts. 

The latest available figures show, as of January 2012, more than 13.5 million people were covered by this type of account, which is more than an 18% increase over the previous year. Some critics have said, HSAs are only appropriate for young and healthy participants. But the American Health Insurance Plans association reports in 2012, about 49% of HSA enrollees are over 40 years old.
 

Health Savings Account Advantages

Here are some of the advantages of HSAs:

Depending on your federal income tax  bracket, you can save between 10% and 37% of amounts contributed to your account.  Every year, the money not spent can stay in the account and earn income tax-free, just like an IRA.
Employers can contribute to employee accounts.
Neither employers nor employees pay taxes on money contributed to HSAs.
Lower health insurance costs mean more businesses can cover employees for major medical problems, such as hospitalization. Employees can use the accounts to cover doctors visits, lab tests and other costs.
Higher contribution limits and rollover privileges allow participants to get more money into their HSAs quickly to meet potential health care bills.
HSAs are portable -- meaning if employees change jobs, they can take the accounts with them.

Here are the basics of how HSAs work, followed by a summary of the favorable changes brought by the law passed in 2006.

HSA Basics

Essentially, HSAs operate like this: Individuals and businesses buy less expensive health insurance policies with high deductibles. Contributions to the accounts are made on a pre-tax basis. The money can accumulate year after year tax free, and be withdrawn tax free to pay for a variety of medical expenses such as doctor visits, prescriptions, chiropractic care and premiums for long-term-care insurance. 

Participating employers can also contribute to accounts, on behalf of employees. HSAs enable self-employed people and businesses which currently do not have health insurance to utilize high-deductible plans with more affordable premiums.

If you're an eligible individual, you can cut your federal tax bills by making deductible HSA contributions. Even better, you can qualify regardless of your income, because there are no phase-out rules for high earners. However, you're allowed to make HSA contributions only if you're covered by a qualifying high-deductible health plan.

For the 2019 tax year, a plan must have a deductible of at least $1,350 for self-only coverage or $2,700 for family coverage to be considered a high deductible health plan (unchanged from 2018). A family plan covers anyone other than just yourself. 

The maximum HSA contribution for 2019  is generally $3,500 for self-only coverage (up from $3,450 in 2018) or $7,000 for family  coverage (up from $6,900 in 2018). However, these contribution maximums are increased by $1,000 if you are age 55 or older as of December 31, 2018, to $4,500 for individual coverage or $8,000 for family coverage.  

Those are the basics. Here are four favorable tax law changes that might make HSAs a good deal for you or your business.

Favorable Change #1:  Contributions Not Limited by the Deductible Anymore

The maximum allowable HSA contribution no longer depends on the amount of the plan deductible, as it did at one time. That means higher potential contributions.

For 2019, the maximum HSA contribution is $3,500 if you have self-only coverage or $7,000 if you have family coverage (or $4,500 or $8,000, respectively, if you'll be 55 or older as of December 31, 2019). The amount of your health plan deductible no longer affects your HSA contribution limit, which means higher potential contributions.

Favorable Change #2:  Eligible in December Means Eligible All Year

An individual who is eligible to make HSA contributions as of the last month of the year is considered to be eligible for the entire year. Therefore, if you are eligible in December of 2019, you can contribute up to the maximum amounts listed above. Previously, HSA contribution eligibility had to be determined on a monthly basis. So if you became eligible part way through the year, you could only contribute a pro-rated annual amount.

While the ability to make a full contribution based on end-of-year eligibility is helpful, a harsh recapture rule can apply if you become ineligible for HSA contributions during the subsequent "testing period." The recapture amount equals the additional contributions deducted under the current rule compared to the pro-rated amount which would have been allowed under the old-law month-by-month rule. The recapture amount is also subject to a 10% penalty tax.

The testing period begins with the last month of the tax year and ends on the last day of the 12th month following that month. The recapture amount is included in income, and the 10% penalty is charged, for the tax year which includes the first day during the testing period when you become ineligible for HSA contributions.

Example to Explain the Recapture Rule: On December 1, 2019, let's say you become covered by a qualifying high-deductible health plan that provides self-only coverage with a $1,500 deductible. If you are under age 55, you can make a deductible HSA contribution of up to $3,500 for 2019 (the maximum allowable amount for individual coverage). However, if you become ineligible for HSA contributions in 2019, you must report recapture income of $3,208 (11/12 times $3,500 equals $3,208) on your tax return and pay the 10% penalty tax on that amount.

Favorable Change #3:  One-Time Rollovers Now Allowed

You can now roll over a distribution from a health care flexible spending account (FSA) or a health reimbursement arrangement (HRA) into an HSA with direct transfers between the accounts. Done right, this is a tax-free maneuver. However, your FSA or HRA plan document must be amended to allow rollover contributions. (Source: IRS Notice 2007-22) Also, the rollover contribution cannot exceed the lesser of the balance in the FSA or HRA as of:

September 21, 2006.
The distribution date.

Warning: To be eligible for this opportunity, you must completely empty the FSA or HRA and cease participating in it after the rollover. Why? Health care FSAs and HRAs are considered heath plans. Since they generally have no deductible, they don't qualify as high-deductible health plans. You're ineligible to make HSA contributions (including rollover contributions) while covered by any health plan which is not a high-deductible plan.

Bottom Line: You can't participate in a health care FSA or HRA and make HSA contributions too. You must choose one or the other. You are only allowed one rollover for each FSA or HRA owned by you to empty the account. These FSA or HRA rollover contributions to an HSA are not deductible, and have no impact on your ability to make "regular" deductible HSA contributions under the rules explained earlier.

Unfortunately, a harsh recapture rule can also apply if you make an FSA or HRA rollover contribution and become ineligible to make HSA contributions during the subsequent "testing period" (for example, because you become covered by a generous health plan). Ask your tax adviser for details if you think you might be affected.

Favorable Change #4:  IRA-to-HSA Rollovers Also Allowed One Time

You can now make a tax-free rollover from your traditional or Roth IRA into an HSA with a direct trustee‑to‑trustee‑transfer between the accounts. (However, this rollover privilege is not available for active SEP IRAs or SIMPLE IRAs.) In general, you are only allowed to make such a rollover one time during your life.

The IRA-to-HSA rollover contribution cannot exceed your "regular" deductible HSA contribution limit for the year (based on whether you have individual or family high deductible health plan coverage) at the time of the transaction. Therefore, the maximum amount you can roll over during 2019 is $3,500 if you have self-only coverage or for family coverage in 2019 the maximum is $7,000. Your "regular" deductible HSA contribution limit for the year is reduced by the amount of your IRA rollover contribution, and you get no deduction for the IRA-to-HSA rollover contribution. 

Again, a harsh recapture rule can apply if you make an IRA rollover contribution and become ineligible for HSA contributions during the subsequent "testing period." If you think you might be affected, ask your tax adviser for details. 

Conclusion: The Health Savings Account tax law changes can be beneficial to individuals and businesses, because they allow larger deductible contributions and the flexibility to make tax-free rollover contributions from health care FSAs, HRAs, and IRAs. But watch out for the nasty recapture rules, and don't engage in any rollover transactions unless you're confident you'll be eligible for HSA contributions during the subsequent 12-month testing period.

Posted in Tax Topics For Individuals

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.

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