Health Savings Accounts (HSA's) – Are They Better Than IRAs?
They could be if withdrawals from traditional IRAs (other than RMDs) are used to pay certain medical expenses, including co-payments. If you had the choice of paying medical expenses with tax-free instead of taxable income, why wouldn’t you opt for the tax-free option? If significant out-of-pocket expenses are planned for future medical expenses, a HSA would certainly be an attractive alternative or addition to an Individual Retirement Account or a Roth IRA.
The contributions into a Traditional IRA are typically tax-deductible; they grow tax-deferred but are taxed when withdrawn to pay for living expenses, including medical costs. A contribution to an HSA is tax deductible, grows tax-deferred, and is tax-free when withdrawn to pay for medical expenses. If the withdrawals are not paid for qualified medical expenses, then the withdrawals are treated as taxable income, but with a hefty 20% penalty imposed until you reach 65. In most cases, IRA withdrawals are typically used for various expenses, and the tax deduction and tax-free growth of an IRA will outweigh the benefits of the Health Savings Account.
Health Savings Accounts are tax-advantaged arrangements used to pay or reimburse certain medical expenses you incur. You can set up an HSA with a trustee. A qualified HSA trustee can be a bank or an insurance company. Many employers have an HSA option. If your employer doesn’t offer it, a bank or certain brokerages will offer HSAs.
Benefits of A Health Savings Account (HSA)
- You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions on Schedule A (Form 1040)
- Contributions to your HSA made by your employer may be excluded from your gross income.
- Contributions remain in your account until you use them.
- The interest and other earnings on the assets in the account are tax-free.
- Distributions may be tax-free if you pay qualified medical expenses.
- See IRA Publication 969 for more information on Health Savings Accounts.
- You must have a high-deductible health plan. You must have no other health care coverage (some exceptions apply).
- The minimum Deductible for 2023 is $3,000 for family coverage and $1,500 for self-only coverage.
The minimum Deductible for 2024 = is $3,200 for family coverage and $1,600 for self-only coverage.
- People eligible for Medicare cannot contribute to HSAs. If you have a balance in an existing HAS, once you turn 65, you can use that money tax-free to pay monthly Medicare Part B and D premiums and out-of-pocket medical costs, even if you are on Medicare.
- You can’t be claimed as a dependent on someone else’s 2022 tax return.
How it Works
- The Contribution limit for family coverage in an HSA plan for 2023 is $7,750, which is actually greater than what is allowed for an IRA contribution of $7,500 (including a $1,000 “catch-up” provision for those over 50). The 2023 contribution limit for self coverage is $3,850. Contributions through an employer are from pre-tax wages, and outside contributions (self-employed, no employer insurance, etc.) are tax deductible. For 2024, these amounts rise to $4,150 and $8,300.
- The HSA can accumulate funds without the “use it or lose it” rule, like flexible spending accounts. For 2023, out-of-pocket costs, including co-payments, cannot exceed $15,000 a year for family coverage and $7,500 a year for individual coverage.
- You do not need to take out HSA funds in the same year you incur the medical cost. If you keep receipts, your HSA can reimburse you in a later year.
- If you take withdrawals from the HSA for non-qualified medical expenses, the withdrawal will be taxable as ordinary income, and there will be a 20% penalty on the withdrawal amount - Ouch!
Annual Withdrawal Limit
Withdrawals each year are limited to $!5,000 per year for family coverage, whether targeted for medical costs or not. The limit for self-coverage is $7,500 per year. In 2024, the limits rise to $16,100 and $8,050 respectively.
Marilyn, age 54, married, is an employee of a company that offers an HSA option. Marilyn contributed to family coverage from 2020 to 2023 (see below). Each year the gains (or losses) are added or subtracted to or from the account balance, very similar to an Individual Retirement Account. The amount she withdrew from her account for medical expenses were minor amounts, but that didn’t change the allowable annual tax deduction of the entire contribution.
If, in January of 2024, she plans a major surgery that insurance does not cover, she is limited to withdrawing $16,100 from the HSA account. Since the balance is $29,400, the $16,100 would be disbursed from the HSA account tax-free, and the remaining $13,300 would remain in the account.
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