HSAs and the Tax Filing Season — Five Things to Know
January means a start of the year, a closure to the old and the welcoming of new. However, somewhere between spring flowers and summer vacation planning lies an annual household chore: Taxes.
Even if this snuck up on you, likely your employer, banks and retirement savings providers, to name a few, have already started distributing end of year tax forms. Include on that list of those sending inbound communications your HSA provider, as they will be providing IRS Forms 1099-SA and 5498-SA for contributions and withdrawals.
As these and other tax forms start arriving in your mailbox and inbox and sending you into a (positive?) tax state of mind, here are five things to keep in mind when it comes to taxes and your HSA:
1. The HSA may be the “Best,” Most Tax-Efficient Retirement Savings Vehicle the US Government has (ever?) Created. Ok, the federal government may have offered a better savings account at some point, but compared with today’s alternatives the HSA is hard to beat. Remember the “triple tax savings” of HSAs, namely pre-tax deposits* (income and payroll), tax-deferred growth and tax-free withdrawals for qualified medical expenses.
By comparison, your traditional IRA or employer-sponsored 401(k)/403(b) is a “tax-deferred” account, meaning while you receive an income tax deduction today, you pay taxes later. Unlike these popular retirement savings accounts, however, you must be enrolled in an HSA-qualified High Deductible Health Plan to make new contributions to your HSA.
[Note — remember, funds deposited in your HSA can continue to grow through dividends, interest and market appreciation, as long as they remain in the account. Your HSA never expires, see below, and the funds are never forfeited, as many FSA programs require at year-end.]
2. The IRS Expects You to Do Your Own Record Keeping. Compared with your IRA and 401(k), your HSA requires more documentation. As noted above, contributions and withdrawals are reported using IRS Forms 1099-SA and 5498-SA. However, taxpayers are responsible for maintaining “adequate documentation” on their medical expenses. Should HSA withdrawals be used for purposes other than qualified medical expenses — again, an acceptable and totally appropriate use (albeit lacking the same tax-free benefits of qualified expenses), under the right circumstances — any taxes and potential penalties (<65 years of age) due are captured under the “other income” line on your Form 1040.
This creates an administrative task — part of the inspiration for our app, HSA Coach — while allowing savers the opportunity to grow their balances through #3…
3. Your HSA Funds and Incurred Medical Expenses Never Expire. Recall qualified medical expenses may be withdrawn from a HSA at any point. Said differently, an expense you pay out of pocket is an indefinite “IOU” against HSA funds. You choose when you want to withdraw money, whether this is at point of sale, at the end of the year, or even decades later.
Further, qualified medical expenses include not only your personal expenses, but also those of your spouse and other tax dependents. Expenses also can include travel to medical appointments, lodging and meals, and a host of other medically necessary items (see IRS pub 502).
As many know, the total family health bill can add up quickly. Which leads to the following…
4. By INVESTING Your HSA You Can Maximize the Tax Savings. Because this IOU is yours forever, a good way for “patient” investors to maximize the tax benefit growth is by pursuing a “buy and hold” strategy with their investment accounts (pun intended). This works even better for HSAs as the money you choose not to withdraw can generate growth and pay for additional future medical expenses.
5. Your HSA is a “Health 401(k),” Only Better — Flexible, Tax-Free Retirement Withdrawals. As noted above, your IRA and 401(k) can be very useful retirement savings tools. Without question retirement savings accumulation through payroll deposits is a “killer app” in automating consumer behavior. However, the tax bill will come due. For traditional retirement accounts this may even happen on the government’s own schedule — part of what is known in the financial advice industry knows as Required Minimum Distributions, or RMDs.
However, HSAs withdrawals are not only tax free for qualified medical expenses, both current and long ago historic, the funds can be withdrawn at your choosing, as mentioned above. Retirement and financial planning experts may also note RMD rules do not apply to HSAs, providing additional wealth management flexibility.
6. Bonus –HSA’s Transfer Tax-Free to Spouses and Become an Estate Asset for Others. To repeat here, your HSA money never expires. While few of us outside of trust and estate lawyers like to dwell on estate planning, it should bring some comfort to know that all your saving and investing can benefit your heirs when you pass away. For your spouse this means the HSA remains an HSA: tax-free withdrawals for qualified medical expenses. For all others this becomes an estate asset, transferring as other tax preferred savings but losing its status as an HSA. Your tax advisor can describe the mechanism and what it could mean for your estate.
About Aaron, CFP, EA
Aaron Benway is a Certified Financial Planner (CFP) and IRS Enrolled Agent (EA). He co-founded HSA Coach, a digital tool to educate consumers on HSAs, track health expenses and other documents, and provide individual financial calculators, to help consumers get the most from their HSA and other savings. To help individuals directly with their financial planning and wealth management requirements he founded AB Financial Planning.
Prior to HSA Coach Aaron was the CFO of HelloWallet, a financial wellness software startup purchased by investment research firm Morningstar. Earlier in his career Aaron was an investor at The Carlyle Group and a nuclear engineer in the US Navy. Aaron has an Electrical Engineering degree from the US Naval Academy and an MBA from Harvard Business School. Aaron lives in the Washington DC area with his wife and two children.