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What is an HSA?
Health Savings Accounts are savings accounts that allow individuals to pay for qualified out-of-pocket medical expenses using pre-tax dollars. Unlike more traditional health care accounts, the funds in an HSA belong to the individual, not the employer or the insurance company, and travel with the individual. In order to take advantage of this tax deferred savings new benefit, individuals must purchase a specific type of health insurance coverage called a High Deductible Health Plan (HDHP).
What is an HDHP?
An HDHP is a different type of health plan. Under an HDHP individuals are covered for large expenses and pay for their day-to-day expenses, usually up to the amount of the deductible. In order to meet the requirements in 2009 an HDHP must have a deductible of at least $1,150 for individuals or $2,300 for families plus certain total out-of-pocket expense maximums.
What are the benefits of an HSA?
An HSA is very similar to an IRA in that:
- Pre-tax dollars can be used to pay for qualified medical expenses
- You are in control of more of your health care decisions
- Funds left in an HSA can grow, tax deferred
- Your account stays with you even if you change employers
- After age 65 you can withdraw your funds and they are only taxed as ordinary income
What expenses are qualified medical expenses?
Qualified expenses include most normal medical expenses such as:
- Doctor visits
- Prescription and over the counter drugs
- Dental services
- Vision care (including contact lenses, glasses and Lasik surgery)
- View a complete list of qualified medical expenses.
How do I open an HSA?
Opening an HSA is very similar to opening a checking account. All you need to do is complete an HSA Application which asks basic information such as, name, address, social security number, date-of-birth, phone number, driver’s license and e-mail.
You may also want to authorize a co-signer on your HSA. An HSA is an individual account and cannot be held jointly; however, we allow for co-signers. An HSA can be used for the benefit of other eligible members in the family (regardless of their insurance coverage) so it is often beneficial for anyone opening an HSA to allow their spouse to have signing privileges. It generally makes sense to only open one HSA per family rather than split the contribution between two spouses’ accounts.
As a custodial or trust account, you are permitted and encouraged to name a beneficiary for your HSA at the time you open it. At the time of death, a spouse beneficiary will have the option to treat the account as his or her own HSA and continue to use the account as an HSA. A non-spouse beneficiary will not be allowed to keep the assets in an HSA and will have to include the amount in the HSA as income. If you do not name a beneficiary, any balance remaining in your HSA will go to your estate.
How much can I contribute to an HSA?
Individuals are allowed to contribute up to $3,000 in 2009.
Families are eligible to contribute up to $5,950 in 2009.
How do I make contributions?
You will generally open your HSA with an initial contribution. This could be a check, an ACH withdrawal from your checking account or a contribution from your employer made payable to the HSA custodian or trustee. You may then want to set up an automatic deposit plan for future contributions. An automatic monthly deposit allows for you to fund your HSA on a regular basis without any hassle. If you prefer, you can make your full annual contribution all at once. Your employer may also make contributions on your behalf or as a benefit to you.
How do HSAs compare to FSAs and HRAs
Health Savings Accounts
- Financed with employee pre-tax dollars and/or employer contributions
- Distributions for qualified medical expenses are tax free (employees required to substantiate)
- Account balance belongs to employee and rolls-over from year to year
- Amount withdrawn after age 65 taxable as ordinary income
Flexible Spending Accounts
- Financed with employee pre-tax dollars
- Distributions for qualified medical expenses are tax free (compliance determined at time of payment)
- Account balance does not roll from year to year; use it or lose it
Healthcare Reimbursement Accounts
- Financed with employee pre-tax dollars and/or employer contributions
- Distributions for qualified medical expenses are tax free (compliance determined at time of payment)
- Unused funds may be carried to future years
The law allows you to use your IRA to fund your HSA. Although this has been true since 2007, the IRS just released detailed rules. This newsletter provides an overview of the rules to do so and links to an IRA to HSA Worksheet that provides the detail if you are interested.
What other option do I have to fund my HSA?
Take money out of an IRA tax and penalty free and put that money into an HSA. This rule gives many Americans a needed source of funds for their HSAs outside of their current income. Similar to a lot of tax laws; however, the relatively simple can become moderately complex once the details are in place. Plus, the concept sounds better than it really is. Only a small percentage of individuals are best served by moving funds from an IRA to an HSA.
Who can fund an HSA with an IRA? You must still be eligible for an HSA, you must have a permitted type of IRA and you can only do one IRA to HSA funding per lifetime.
What types of IRAs can be used? Only certain types of IRAs are permitted: traditional IRAs, Roth IRAs and sometimes SEP IRAs and SIMPLE IRAs. SEP and SIMPLE IRAs are not permitted if they are "ongoing" plans. You cannot use a 401k directly. You may be able to do a rollover from a 401k to an IRA and then move the assets to an HSA.
How much money can an HSA owner move from the IRA to the HSA? The maximum you can move is your HSA federal HSA limit for the year: $3,000for individuals and $5,950 for families for 2009, plus a catch-up of $900 if you are between ages 55-65. You do not get the IRA to HSA funding in addition to other contributions. Accordingly, you need to coordinate the IRA to HSA amount along with any employer contribution, payroll deferral, or other direct HSA contributions for the year to make sure the combined amount does not exceed the federal limit.
What is the tax impact? IRAs and HSAs are creations of the tax code and the main reason to complete an IRA to HSA funding should be tax driven. If nothing else, this rule gives you a method to avoid paying taxes and penalties on an IRA distribution necessary to pay medical expenses.
The IRA to HSA contribution is not tax deductible. This makes sense because the distribution from the IRA is treated as a "qualified HSA funding distribution" and is not subject to taxes or penalty (if an early withdrawal). You do not pay taxes on the IRA distribution therefore you do not get to claim that tax deduction for the subsequent HSA contribution.
Essentially you are trading one tax-favored account, the IRA, for another, the HSA. Financial planners generally advise individuals to maximize their tax-favored accounts. With that goal in mind, a common recommendation would be to keep an IRA as is and fund an HSA with other funds to maximize contributions to tax deferred accounts. By using other funds, you will get a federal income tax deduction for the HSA contribution and protect the IRA for the future. The IRA to HSA funding option will generally appeal to individuals that do not have other funds available.
Whether the HSA is a better account depends on your circumstances. HSAs and IRAs share many of the same tax attributes; however, the HSA is arguably a better spot for money than an IRA from a tax perspective. The key difference is that the HSA can be used to pay for medical expenses tax free and the IRA cannot. Even this basic difference requires examination if you would use a Roth IRA to fund the HSA, rather than a traditional deductible IRA because Roth IRA contributions can be withdrawn tax and penalty free. The decision to move money from an IRA must be made only after a careful review of both the circumstances and the law to determine if it is appropriate. Seek your own professional tax advice as we cannot and do not provide tax or legal advice.
• Roth IRA or Nondeductible IRA Basis Recovery. The tax situation becomes more complicated if an individual moves money from a Roth IRA or a non-deductible traditional IRA with basis. For the purposes of an IRA, basis is the amount in an IRA that is not subject to taxes when it is distributed because it never received an income tax deduction when initially contributed.
All contributions to Roth IRAs are after-tax and have basis. The earnings in a Roth IRA or non-deductible traditional IRA are tax-deferred, meaning the earnings grow federal income tax-free until distributed. The IRA to HSA rules allow the entire basis to stay with the IRA where it can be recovered at the time of distribution from the IRA. No basis transfers to the HSA.
This is very favorable treatment, albeit a bit complex to track. If you do not have enough non-basis money in an IRA and still chooses to move the money into the HSA, you lose the basis in that amount moved into the HSA. You should seek professional tax guidance because losing basis could have serious tax consequences. Still, in limited circumstances, it may make sense to move funds with basis into an HSA.
• Testing Period Applies. If you move money from an IRA to an HSA, you will be subject to a testing period. You must maintain HSA eligibility for the twelve months following the transaction.
For example, if an individual moves money from an IRA to an HSA on August 5, 2008, the testing period will begin on August 1, 2008 and end on August 31, 2009. The individual must remain eligible for the HSA that entire period or the amount of the IRA to HSA transfer is subject to taxation and a 10% penalty. If the individual loses HSA eligibility due to death or disability, he or she will still pass the test.
How does the IRA to HSA transaction take place? The money must move as a "direct transfer." This means that you cannot gain direct access to the funds. Generally the direct transfer occurs by the IRA custodian or trustee working directly with the HSA custodian or trustee to send the funds directly.
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