Health savings accounts, or HSAs, are increasingly prevalent as an employee benefit. Financial advisors can provide great value by helping their clients understand how HSAs work and take advantage of their triple tax benefits.
Each year, the IRS sets the contribution limits for HSAs, which are tax-advantaged savings accounts by which people can contribute pre-tax earnings to invest and save for qualified medical expenses. For 2021, an individual who qualifies for an HSA can contribute up to $3,600 for a self-only plan and $7,200 for family coverage. For 2022, the self-only limit went up to $3,650, and the limit for family coverage went up to $7,300. There is no change from 2021 to 2022 for the catch-up contribution. For individuals ages 55 or older, there is an additional catch-up contribution of $1,000 allowed.
Although there are no income limits for HSA eligibility, individuals must meet certain requirements as defined by the IRS:
— You must be covered under a high-deductible health plan, or HDHP, on the first day of the month.
— You have no other health coverage other than what is permitted by the IRS.
— You aren’t enrolled in Medicare.
— You can’t be a dependent on someone else’s tax return.
Financial advisors can help clients navigate the triple tax advantages of HSAs by helping them plan for the future while lowering their taxable income today. Here are some of the ways that advisors can help clients take advantage of the benefits of HSAs:
— Lowering taxes today.
— Taking advantage of tax-free earnings.
— Making tax-free qualified distributions.
[SUBSCRIBE: Get the weekly U.S. News newsletter for financial advisors. ]
Helping Clients Lower Taxes Today
Contributions to an HSA are done on a pre-tax basis. Clients can take a deduction on their tax return for amounts that they contribute to their HSA, even if they don’t itemize their deductions. They do not have to include in their gross income any contributions made by their employer. Contributions can be made pre-tax via payroll deductions or deducted on the tax return if contributions were made after tax.
In addition to not triggering income taxes on the contributions, HSAs are also exempt from payroll taxes, also known as FICA taxes. For advisors with clients who are able to max out their 401(k) contributions, maxing out an HSA will add even more tax benefits by helping clients lower their income further.
Not to be confused with a flexible spending account, or FSA, HSAs do not have a “use it or lose it” provision. Amounts not spent on qualified medical expenses roll over year after year and remain in the account until used.
Make your clients aware of the contribution limits so that they do not over-contribute. Excess contributions are not tax-deductible and are included in gross income. There is also a 6% excise tax on excess contributions for each tax year the excess contribution remains in the account.
As with IRAs, clients have until the tax filing deadline to make contributions to their HSAs for the previous tax year. If your client is eligible and has not taken advantage of their HSA for 2021, they still have time to contribute. If the employer makes a contribution between January 1 and April 18, 2022, for tax year 2021, the contribution will likely be reported on the 2022 W2.
Taking Advantage of Tax-Free Earnings
The funds in a HSA can be invested in things like stocks, bonds, mutual funds and exchange-traded funds. The growth and earnings of these funds are tax-free while they remain in the HSA, similar to a Roth IRA. Financial advisors can help clients strategize by taking into account the funds in their HSAs as part of their overall investment strategy.
If a client does not need to use their funds for health care expenses, the HSA can be used as part of the clients’ overall investment portfolio and should be considered when allocating the rest of their assets.
Similar to how advisors help clients rebalance their 401(k)s, advisors can help their clients rebalance the investments in their HSA each year.
Making Tax-Free Qualified Distributions
One major expense that retirees face is health care costs. Financial advisors can help their clients plan for these expenses by taking advantage of HSAs. If funds are used for qualified medical expenses, the distributions are also tax-free.
Having funds in a health savings account that can be used tax-free for qualified medical expenses during retirement will help reduce distributions from other assets the client has, while also providing for a tax-advantaged distribution strategy.
Be aware of the penalties if funds are not used for qualified medical expenses. Before age 65, non-qualified distributions from HSAs are taxed as ordinary income plus a 20% penalty. The penalty does not apply on non-qualified distributions made after being considered disabled, age 65 or older, or death.
If the holder of an HSA dies and the spouse is the designated beneficiary, the HSA will be treated as the spouse’s HSA. However, if the beneficiary is not a spouse, the market value of the HSA becomes taxable to the beneficiary in the year of death. If an estate is the beneficiary, the value of the HSA is included on the person’s final income tax return. Any taxable amount to a beneficiary other than the estate can be reduced by any qualified medical expenses for the decedent that are paid by said beneficiary within one year after the date of death.
More from U.S. News
How to Advise Clients on Wash Sale Rules
What Is an Irrevocable Life Insurance Trust and Do You Need One?
How Financial Advisors Can Build Their Client Base and Keep Them Engaged
Help Clients Take Advantage of the Triple Tax Benefits of HSAs originally appeared on usnews.com
