With increasing medical costs for both insurance premiums and copays, individuals look for alleviation through income tax deductions.  Health Savings Accounts (HSAs) are considered one of the most tax advantaged strategies in the current tax code.

If you qualify to contribute (by having a qualifying high deductible health insurance plan as discussed below) the money that you deposit is a current year income tax deduction, up to the certain limitations.  The funds can be invested in a variety of options and the earnings within the HSA grow income tax free, like a retirement account.  Additionally, when the funds are withdrawn from the HSA and used for qualifying medical costs, the portion of distributions that relate to both contributions and earnings are income tax free.

To qualify for a Health Savings Account, one must meet the following requirements:

  • Be covered by a high deductible health plan (HDHP) with the following stipulations:
    • Has a higher deductible than typical health plans. The minimum annual deductible (for 2023) is $1,500 for self-only coverage and $3,000 for family coverage.
    • Has a maximum limit on the sum of the annual deductible and out-of-pocket medical expenses. The maximum annual deductible (for 2022) is $7,500 for self-only coverage and $15,000 for family coverage.
  • Have no other coverage, including Medicare.
  • Not claimed as a dependent on another’s tax return.

The contribution amounts are updated annually for both single and family coverage.  For 2023, if you have self-only HDHP coverage you can contribute up to $3,850 or if you have family coverage you can contribute up to $7,750 into a family HSA.  If you are 55 or older at the end of the tax year, you can contribute an additional $1,000 on top of the annual limitations.

There is a “marriage penalty” for HSA owners to be aware of.  While 2 married individuals can both open separate HSA accounts, they are limited to the family coverage contribution amount which is less than 2 separate self-coverage amounts for individuals over 55.  The contributions can be split evenly between both separate accounts, or one spouse can contribute more than the other as long as the final contributions do not exceed the self only limit per account and the family coverage limit combined.  For example in 2023, two married individuals over 55 can contribute $4,375 into their own HSAs (total contribution of $8,750) or can split it $4,850 (max per individual) and $3,900 into the other spouse (total contribution of $8,750).  Additionally if one spouse has a family coverage account (with dependent children) and the other spouse has their own plan, they are limited to combined contributions equal to the family account limit as well. 

Contributions to your HSA can be made through April 15th of the following year and deducted on the previous year’s tax return.  So, 2023 contributions can be made by April 15, 2024, and deducted on your 2023 tax return.

There are a few states that do not recognize HSA accounts.  Contributions are not tax deductible in California or New Jersey.  These states as well as New Hampshire and Tennessee also tax the earnings (interest, dividends, and capital gains) on HSA accounts.  Therefore, it is important to understand your state’s treatment of HSAs before enrolling.

Distributions used for qualifying medical expenses are not taxable income and can be taken out in the same year or grow income tax fee for years before withdrawing.  Qualifying expenses are medical expenses that would be deductible as medical and dental itemized deductions.  See IRS Publication 502, Medical and Dental Expenses, for annual updates.  The qualified medical expenses can be for the taxpayer, their spouse, and all dependents claimed on their tax return.  Distributions not used for medical expenses are fully taxable at ordinary income rates plus are subject to an additional 20% federal penalty if withdrawn before the age of 65 (unless disabled).

When an individual transitions to Medicare coverage, they are no longer eligible to contribute to an HSA account since Medicare is not a qualifying high deductible insurance plan.  Moreover, Medicare is retroactive 6 months before the date of coverage, so HSA contributions must end 6 months prior to Medicare enrollment.  To figure your annual contribution limit in the year that you start Medicare coverage, multiply your full annual contribution amount by the portion of the year you were eligible.  

Example, if you qualify for Medicare in the month of November your coverage is retroactive to April and you can contribute to an HSA account for January through March or 3/12 months.  Multiply that fraction by the annual contribution limit of $4,750 (for 2023, plus the catch-up contribution); your annual contribution is limited to $1,187.50 (3/12 x $4,750).

If you have questions about Health Savings Accounts for your unique situation, please reach out to a member of our team.

 

Aura Advisors is a boutique tax consulting and compliance firm working with start-ups, emerging growth companies, and affluent individuals. Making it safer for good people and good companies to continue to do good things.