A Health Savings Account can be an important part of your tax and money-management strategy. Not only can you reduce your health insurance premiums, but when you fund your account you get a nice tax break. If you stay healthy, that money grows tax-deferred like an IRA, and can amount to a lot of money in retirement.
Every year around this time you should assess your finances and see what you need to do to optimize your situation. Making the most of your Health Savings Account (HSA) is one area that can really make a difference. Here are the key things you need to know to get the greatest tax reduction and the most growth out of your HSA.
Maximizing Your Contribution May Reduce Your Taxes By $1836 or More
If you own an HSA-qualified health insurance plan that has an effective date no later than December 31, 2007, you qualify to make a tax deductible contribution to your Health Savings Account. This will immediately reduce your tax bill come April 15.
The contribution limit is not pro-rated based on the number of months in 2007 in which you had coverage, as it was in the past. However, you do need to remain an HSA-eligible individual throughout 2008, or the extra amount contributed will be counted as income and subject to an additional 10 percent tax.
The maximum HSA contribution in 2007 is $5650 for families, and $2850 for individuals. If you are 55 or older, you may also contribute an additional $800.
Your HSA contribution is deductible on your federal income taxes, and every state (except AL, CA, NJ, and WI) also gives a deduction on state income taxes. So by maximizing their HSA contribution a family in a 28 percent tax bracket, paying 4.5 percent state income taxes, will reduce their April 15 tax burden by $1836.25.
Though your HSA-qualified health insurance must be in place before the end of the year, you do have until April 15 to make your 2007 contribution. Though you cannot put any more 2007 money in if you miss this deadline, you can reimburse yourself in later years for qualified expenses incurred in 2007, even if you do not currently have the money in your account.
Strategic Withdrawals
You can withdraw money from your HSA at any time to pay qualified medical expenses. Keep in mind that this includes over-the-counter medications such as aspirin or cough syrup, dental and vision expenses, and even alternative care such as acupuncture or homeopathy.
One strategy that many of our members take is to save their medical receipts, but to delay reimbursement from the HSA so that the funds have the opportunity to grow tax-deferred. There is no time limit in which you must withdraw the money. Since most people will face larger medical bills during their retirement, it is quite likely that the withdrawals would never be subject to taxes.
If you are not fully funding your Roth, another strategy would be to reimburse yourself for medical expenses from your HSA, and to deposit it in your Roth. Your HSA reimbursement is tax-free, and placing it in your Roth would also give you tax-free growth while enabling you to withdraw the money in retirement tax-free for any reason, including non-medical expenses. You would also avoid any extra state taxes in the states that currently tax Health Savings Accounts.
Remember to Keep Good Records
You should keep a record of any qualified medical expenses you incur. This will ensure that you have documentation substantiating any tax-free withdrawal you make from your HSA. In order to pay for a medical expense from your HSA, it must be a qualified expense.
You can go low-tech and just put receipts in a file, or get a little more organized and track your records online.
2008 Contribution Limit and Deductible Changes
In 2008 the maximum annual HSA contribution limit will again go up, this time to $2900 for individuals and $5800 for families. Those over age 55 will be allowed to contribute an additional $900 to their accounts.
The maximum deductibles will be going up next year to $5600 for individuals, and $11,200 for families. If you’ve now got some money socked away in your HSA, it might make sense to move to a higher deductible to further reduce your premiums.
Health Reimbursement Arrangements
If you are currently set up as an S-corp, you should strongly consider setting up a Health Reimbursement Arrangement (HRA). An HRA enables your S-corp to reimburse you as a tax-free fringe benefit for the cost of your individual health insurance. This is the only way an S-corp can legally pay for individual health insurance, and is saving our average S-corp member over $3000. The HRA must be established by December 31st in order to take advantage of it in 2007.
It may also be beneficial to set up an HRA if you have a spouse who works in your business. Also, many small businesses use an HRA to reimburse their employees for individual health insurance premiums (which is much less expensive than getting group coverage). More information and a simple online application is available on our Health Reimbursement Arrangement page.
What to Do Now
Here are the steps you should take now:
- To maximize the potential growth of your funds, you should try to fund your account as early in the year as possible. Every month of tax-deferred growth does add up over time. You can keep the money in a savings account, or invest it in stocks or mutual funds.
- If you have your health insurance in place but do not yet have your HSA set up, you can do so online or possibly your local bank.
- If you do not yet have an HSA-qualified health insurance plan, you should apply for coverage as soon as possible. Your plan must be effective before January 1 in order for you to qualify for the 2007 tax deduction. By getting your HSA-qualified health insurance in place by January 1, not only will you be able to maximize your tax benefits, but you also may be able to lock in 2007 rates for the next 12 – 24 months.
- If you have a small business with employees, are set up as an S-corp, or have a spouse who works in the business with you, you should set up a Health Reimbursement Arrangement.
Through HSAs and HRAs, individuals who pay for their own health insurance have some powerful tax reduction strategies at their disposal. December 31st is the deadline for obtaining 2007 tax deductions, so you should act.