As medical expenses continue to rise and high-deductible health insurance plans become more prevalent, the popularity of Health Savings Accounts (HSAs) has surged since 2017. According to the Wall Street Journal, the number of HSA account holders stood at 17 million in 2017, but this figure leaped to 28 million by 2022.

The crucial questions at hand are whether consumers are aware of the common traps associated with HSAs and whether they are effectively leveraging HSAs to reap their full range of benefits. Like any financial tool, it is important to engage in strategic planning to integrate your HSA with your broader financial landscape.

Contribution Limits and Qualifications

In 2023, the maximum HSA contribution is set at $7,750 for families and $3,850 for individuals, with an additional $1,000 allowable for participants that are age 55 and above. Generally, any unused funds within the HSA can be invested, fostering tax-free growth. If an employer makes contributions to the HSA, this dollar amount is included in the annual maximum. For example, if a 50-year-old is covering their family under a high-deductible health insurance plan, and the employer seeds the account with $250, the employee can fund another $7,500 for the year.

To be eligible to fund an HSA, an individual must be enrolled in a high-deductible health insurance plan and not enrolled in Medicare. These types of insurance plans typically come with family deductibles ranging from $5,000 to $15,000. To ease the financial strain on employees, these insurance plans are commonly coupled with tax-advantaged savings tools such as HSAs.

Utilization of HSAs

Typically, employees contribute pre-tax dollars to HSAs and take tax-free withdrawals as medical expenses present themselves. Moreover, the funds within an HSA can be invested, capitalizing on the opportunity for tax-deferred growth.

An often-neglected feature of HSA accounts is that they allow holders to cover healthcare costs retrospectively, provided the HSA was established prior to the medical incident. This implies individuals capable of paying medical expenses at the time incurred, can still channel funds into an HSA account. Subsequently, when a financial need arises down the line, they retain the option to withdraw funds entirely tax-free to reimburse for the previously incurred qualified expense. To utilize this strategy, the account holder must provide proof of payment in the form of a receipt to the IRS.

Funds in an HSA are not “use it or lose it” each year. The unused balance rolls forward and can provide more planning opportunities. Even funds in an HSA post-retirement and after you are enrolled in Medicare can be used to cover medical expenses. Long-term care insurance premiums and your Medicare Parts B and D, as well as Medicare Advantage plan premiums are all eligible expenses. However, HSA funds cannot be used to pay for Medigap premiums.

Challenges of Inheriting Funds in an HSA

If a spouse is named as the beneficiary of an HSA, the inherited account can maintain its tax-deferred status. It will then be treated as your spouse’s HSA. If the account is inherited by a non-spouse, the account stops being an HSA and the new account owner includes the full balance in their taxable income. Beneficiaries have one year from the date of death to use the HSA funds for previously unreimbursed qualified medical expenses of the decedent to reduce what will be included in their taxable income.

It is important that the HSA account owner updates their beneficiary information to ensure that the assets pass to the appropriate party. If you name someone other than a spouse as the beneficiary of an HSA, it is crucial that you communicate with them so they can plan for a potential increase in their taxable income.

Can Children Open HSA Plans?

Yes, as long as the child is not claimed as a dependent and is still covered under their parent’s high-deductible plan. For example, let's assume that Sarah, age 23, recently graduated from college and meets the requirements above. She may open an HSA and contribute the full family contribution limit for 2023 of $7,750. Sarah can fund the account with her earnings or use funds gifted to her by someone else.

Withdrawals From HSAs for Non-Medical Expenses

If you withdraw funds from an HSA for nonmedical expenses before you turn 65, the funds withdrawn will be included in your taxable income and will be subjected to a 20% penalty. However, if you wait until you turn 65 (or older) to withdraw the funds for nonmedical expenses the amount withdrawn will be included in your taxable income but will not be subjected to the 20% penalty.

Summary

HSAs can be used in a variety of ways to fit your financial situation. If you qualify for an HSA but choose not to contribute, you are most likely leaving money on the table. Conversely, if you actively contribute to an HSA, it is crucial that you are aware of the common pitfalls as well as understand how to take full advantage of the tax-advantaged status. HSAs are a powerful planning tool and can be used to help you achieve your financial goals.

As you plan for the future, the experts at Busey Wealth Management are here to help. To find an advisor near you or to learn more about our holistic and comprehensive services, visit busey.com/wealth-management.

This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.

This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.

This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.

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