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Insider secrets-how an HSA plan can save you taxes & premiums

This presentation is adopted from a presentation made in an advanced tax planning class as part of the curriculum for my Master’s in Tax & Financial Planning at San Diego State University. Although it highlights many of the HSA basic concepts, it is actually designed to focus on a little known “secret” behind the HSA plan—the ability to by-pass the 7.5% AGI limitation required before most people can ever deduct any of their medical expenses. I hope you enjoy!

C. Dean Richard, JD, MSBANeedless to say, all contents ©2008, all rights reserved.

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Health Savings Account Plans

By now, almost everyone knows that an By now, almost everyone knows that an HSA plan allows you to use TAX-FREE HSA plan allows you to use TAX-FREE

money to pay most medical expensesmoney to pay most medical expenses

But did you also know . . . But did you also know . . .

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An HSA also allows you to:

By-pass the 7.5% AGI Limitation and deduct By-pass the 7.5% AGI Limitation and deduct (almost) all of your medical expenses ….(almost) all of your medical expenses ….

BEFOREBEFORE they are incurred! they are incurred!

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What is an HSA?

A tax-sheltered savings account designed A tax-sheltered savings account designed specifically for medical expensesspecifically for medical expenses

Predecessor: Medical Savings Accounts Predecessor: Medical Savings Accounts (MSA), born in the Kennedy-Kassalbaum (MSA), born in the Kennedy-Kassalbaum Bill of 1996 (also known as “HIPAA”)Bill of 1996 (also known as “HIPAA”)

Revitalized in 2004 as part of the Revitalized in 2004 as part of the Medicare Reform Act of 2003Medicare Reform Act of 2003

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Tax-Advantages—the Basics

100% of your annual contribution 100% of your annual contribution to your savings account is deductible to your savings account is deductible “above the line”“above the line”

Earnings accumulate tax-deferred Earnings accumulate tax-deferred (can invest in almost anything)(can invest in almost anything)

Withdrawals are TAX-FREE (if Withdrawals are TAX-FREE (if used for qualified medical expensesused for qualified medical expenses

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Similar to an IRA

Sounds like an IRA?Sounds like an IRA?

YES!!YES!!

(“it’s a medical IRA”)(“it’s a medical IRA”)

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Who is eligible?

Almost everyone, including:Almost everyone, including:

Self-Employed (sole proprietors, Self-Employed (sole proprietors, partners, sub-S stockholders)partners, sub-S stockholders)

Employees with a company sponsored Employees with a company sponsored HSA qualified insurance plan in placeHSA qualified insurance plan in place

Anyone with enough earned income to Anyone with enough earned income to at least equal the HSA contributionat least equal the HSA contribution

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What is the Catch?

You must You must firstfirst purchase a special purchase a special health insurance policy: “HDHP” health insurance policy: “HDHP”

(High Deductible Health Plan)(High Deductible Health Plan)

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HSA Insurance Policy (“HDHP”)

Type of Coverage

Minimum Deductible

Maximum Deductible

Maximum Annual Out-

of-Pocket

SINGLE 1,100 5,600 5,600

FAMILY 2,250 11,200 11,200

Specified Deductible and Out-of-Pocket rangesSpecified Deductible and Out-of-Pocket ranges

*For 2008 Tax year

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What is the Catch? (con’t...)

Only Only afterafter you become insured with an HSA-qualified you become insured with an HSA-qualified health plan can you then open and fund the actual HSA health plan can you then open and fund the actual HSA savings account. savings account.

  POINT: The savings account is POINT: The savings account is totally separatetotally separate from from the high deductible insurance policy required to establish the high deductible insurance policy required to establish eligibility for the savings account.eligibility for the savings account.

So, yes, you must pay premiums an an insurance policy So, yes, you must pay premiums an an insurance policy in addition to making any contributions to the savings in addition to making any contributions to the savings account.account.

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Why would anyone want an HSA?

Basic concept: Pay a much smaller premium on your Basic concept: Pay a much smaller premium on your insurance policy—because of the higher deductible—and insurance policy—because of the higher deductible—and take the difference and set it aside in a special savings take the difference and set it aside in a special savings account, basically to cover the “small” medical bills yourselfaccount, basically to cover the “small” medical bills yourself—and let the insurance policy pay just the “big” bills.—and let the insurance policy pay just the “big” bills.

POINT: In theory, this is usually a more efficient way to POINT: In theory, this is usually a more efficient way to fund your own health care, especially if you have to fund it fund your own health care, especially if you have to fund it yourself. This argument loses ground if someone else yourself. This argument loses ground if someone else provides your coverage at little or no cost, or if you have pre-provides your coverage at little or no cost, or if you have pre-existing health conditions that require costly upkeep. existing health conditions that require costly upkeep.

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Government “encouragement”

Tax deduction for merely Tax deduction for merely savingsaving money money

100% tax deductible contributions! 100% tax deductible contributions!

Tax-free withdrawals! Tax-free withdrawals! (for qualified expenses)(for qualified expenses)

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AGI “By-Pass”

Compare an HSA to the “other way” you can get a deduction for medical expenses—you have to spend money. Schedule A—Itemized Deduction for medical expenses. Limited to 7.5% of AGI. Key term: Expenses. Ordinarily, you have to spend money, i.e., incur expenses in order to get a tax deduction.  Which would you rather have: A deduction for expenses incurred or for money contributed to a savings account?

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Example:

Bill & Susan, both age 44, with 2 kidsBill is self-employed contractorAGI: $77,000Medical “expenses” for the year: $1,600 (by law, does not include insurance premiums paid!)

 Amount of deduction: ZEROWhy?: 7.5% threshold is not reached until $5,775 in expenses are incurred

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Example (cont.):

Compare the HSA. Contribution to HSA: $5,800Amount of Deduction: $5,800Estimated Tax Savings: $1,624 (28%) Bill & Susan can actually use “tax dollars” to pay all of their medical expenses and still have $4,200 saved and hard at work earning tax-deferred interest (or investments). Duh! (5,800 contribution – 1,600 medical expenses = 4,200 balance)

 **Actual insurance premiums are also 100% deductible for the self-employed under either option.

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Limitations on Annual Deduction

Lesser of:

Earned income, orMaximum allowable annual contribution

$5,800families $2,900 single person plans

Additional contribution up to $900 allowed as “catch-up” provision for individuals 55+.

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Other Important Factors-Penalties

15% tax penalty for withdrawing money not used for eligible medical expenses prior to age 65 (after 65, basically used as IRA—no penalty for “early” withdrawal, but is includable in gross income, unless used to pay qualifying medical expenses)

Ordinary income if withdrawn for ineligible expenses (at any age)

6% excise tax for contributing more than allowable amount each year

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Eligible Expenses:

Withdrawals are tax-free and penalty-free at any age if made to pay any of the eligible expenses:

NOTE: This is the same list used by the IRS to determine if medical expenses you claim qualify for the 7.5% AGI deduction!

• ambulance • gum treatment • prescription medicines

• anesthetist • gynecologist • psychiatrist

• eyeglasses • pediatrician • physician

• blood tests • hospital bills • psychoanalyst

• arch supports • healing services • psychologist

• lab tests • hearing aids • neurologist

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Deadlines?

If a qualifying health insurance policy is in place by Dec. 1, a taxpayer is eligible for the full contribution for the entire tax year.

Contributions may be made up until April 15.