Written by Kyle Crouthamel, CPA, CFE, Manager
The cost of health insurance for employers continues to rise as elective procedures, healthcare supplies and services, and specialty drug prices increase. Growing costs are driving more employers to limit plan options available to employees, many of which are considered high deductible health plans (HDHP). High deductible plans are aimed to encourage employees to attain necessary and more affordable care to avoid expensive and excessive services. Unfortunately, these plans can be an economic burden to those who incur frequent or emergency health care services as it requires participants to pay higher amounts out of pocket before the insurance plan coverage will pay providers.
Facts
To be considered a HDHP in 2022, the plan must have a deductible of at least $1,400 for an individual or $2,800 for family coverage. These figures are subject to annual adjustments by the IRS. In 2003, as more plans began meeting these perimeters, the United States government created a tax-beneficial savings instrument called the Health Savings Account (HSA). HSAs are personal savings accounts that can be used for eligible health care expenses such as deductibles, prescriptions, and select over-the-counter medicines.
Benefits
HSAs have a unique benefit in that they are a triple tax-advantage account. First, taxpayers who add to an HSA will not pay income taxes on their contributions. If contributed through an employer-sponsored cafeteria plan (Section 125 plan), the contributor will avoid Social Security and Medicare tax as well. This fundamentally will save an additional 7.65% of taxes for the employee and 7.65% for the employer. Second, any accumulated gains within the HSA are tax-free. Lastly, distributions from the HSA are not taxed so long as they are for eligible expenses. These factors poise HSAs to be more tax-advantageous than retirement-related accounts such as 401(k) and IRAs in that you receive a tax deduction when adding to it (the key benefit of a 401(k) or Traditional IRA) and tax-free growth and distribution when removing funds from it (the key benefit of a Roth 401(k) or Roth IRA).
Additionally, many HSA brokers allow participants to invest a portion of their account balance in the stock market. Investments options commonly consist of stocks, bonds, ETFs, mutual funds, and CDs, much like the previously mentioned 401(k) and IRA accounts. These investment options give account holders the opportunity to grow their tax-deferred money in a similar manner to their retirement account with the chance to take the accumulated money out tax-free.
Finally, account holders that reach age 65 who have undistributed funds in their HSA have more flexibility as they can distribute funds from the HSA for expenses that are not for health care related. The caveat is that they will pay federal income taxes on the funds, effectively being taxed in the same manner as a 401(k) or a Traditional IRA.
Disadvantages
While an HSA can be an effective savings tool for some, there are considerations to keep in mind when funding and taking distributions. Any distribution that is not considered a qualified expense is taxable to the distributor, much like 401(k) and Traditional IRAs. However, ineligible distributions from an HSA for those under age 65 are subject to a 20% penalty whereas 401(k) or Traditional IRA distributions are subject to a 10% penalty for those under age 59 ½. The increased penalty should be evaluated for individuals who may have a need to access these funds.
Limits
As with other tax-deferral mechanisms, the IRS sets contribution limits which are adjusted for annually. For 2022, the contribution limit to HSAs is $3,600 for individuals and $7,200 for family coverage with a $1,000 “catch-up” for those between ages 55 and 65. These HSA contribution limits include all contribution sources. Therefore, an individual with family coverage whose employer contributes $1,000 to their plan can only contribute the balance of $6,200 to the HSA.
Conclusion
HSAs can be an effective way to reduce tax liability by earmarking savings for healthcare expenses. Some choose to use the funds for medical expenses or emergencies in the short-run, others supplement traditional retirement accounts for post-working years, which tend to have more medical expenses. Whichever the rationale, the employee’s drawback of a HDHP can be considered a taxpayer advantage if properly executed.
