I am newly independent. Should I open a health savings account?

With healthcare costing so much, and more every year, you should know about Tax-Smart Health Savings Accounts (HSAs), especially if you’ve recently become self-employed. Here is the story.

If you are self-employed, opening an HSA means taking more responsibility for your own healthcare costs instead of relying on the government. The good news: HSAs offer some great tax advantages, which are explained in this column.

According to a recent report per Becoming (an HSA investment provider), HSA assets have grown to approximately $98 billion as of 12/31/21, held in approximately 32 million accounts. This was a year-over-year increase of 19% for assets and 8% for accounts. Becoming predicts that by the end of 2024, there will be approximately 38 million HSAs with assets approaching $150 billion.

In 2010, the Employee Benefits Research Institute reported that there were 5.7 million HSAs with account balances totaling $7.7 billion. Wow. HSAs are obviously gaining ground at a rapid pace.

The Basics of Health Savings Accounts (HSA)

Under the Affordable Care Act (also called Obamacare), health insurance plans are classified as bronze, silver, gold, or platinum. Bronze plans have the highest deductibles and the least generous coverage and are therefore the most affordable. Platinum plans have no deductible and cover a lot more, but they’re also a lot more expensive. In many cases, the ACA has resulted in large premium increases, even for those who prefer less generous plans. However, having an ungenerous plan may make you eligible to open and contribute to an HSA with the resulting tax advantages.

For the 2022 tax year, you can make a deductible HSA contribution of up to $3,650 if you have qualifying stand-alone coverage or up to $7,300 if you have qualifying family coverage (anything other than a stand-alone coverage).

For 2023, the maximum contributions will be $3,850 and $7,750 respectively. If you are 55 or older at the end of the year, the maximum contribution increases by $1,000.

You must have an eligible high-deductible health insurance policy and no other general medical coverage to be eligible for the HSA contribution privilege. For 2022, a high deductible policy is defined as a policy with a deductible of at least $1,400 for personal coverage or $2,800 for family coverage. For 2023, the minimum deductibles will be $1,500 and $3,000 respectively.

For 2022, eligible policies may have maximum payouts of up to $7,050 for personal coverage or $14,100 for family coverage. For 2023, the maximum disbursements will be $7,500 and $15,000 respectively.

Key point: For purposes of HSA eligibility, health insurance premiums are not considered reimbursable medical expenses.

Tax treatment of HSA contributions

If you are eligible to make an HSA contribution for the tax year in question, the deadline is April 15 of the following year (adjusted for weekends and holidays) to open an account and make a deductible contribution for the previous year. Thus, there is still plenty of time for an eligible individual to open an account and make a deductible contribution for 2022, as the deadline is 4/17/23.

The write off of HSA dues is an above the line deduction. This means you can take the write-off even if you don’t itemize. More good news: the HSA contribution privilege is not lost just because you make a lot of money. If you are covered by eligible high-deductible health insurance, you can contribute and collect the resulting tax savings. Even self-employed billionaires can contribute if they have eligible high-deductible health insurance coverage and meet the other eligibility requirements explained below.

Key point: Sole proprietors, partners, LLC members, and S-Corporation employee-shareholders are generally allowed to claim separate top deductions for 100% of their health insurance premiums, including premiums for deductible coverage. high that makes you eligible for HSA dues.

Example 1: You and your spouse are a co-filing married couple. You are both self-employed and each have HSA-compatible individual health insurance policies for the whole of 2022. Both policies have deductibles of $2,000. For the 2022 tax year, you and your spouse can each contribute $3,650 to your respective HSAs and thus claim a total of $7,300 in tax depreciation on their 2022 joint 1040 form. 24% federal tax, this strategy reduces your 2022 tax bill by $1,752 (24% x $7,300). If you run this exercise for 10 years, you’ll save $17,520 in federal income tax – assuming you contribute $7,300 each year and stay in the 24% bracket. You may also be eligible for state income tax savings. Plus, you’ll have whatever’s accumulated in your HSA balances.

Example 2: For all of 2023, you will have eligible family health insurance coverage with a $4,000 deductible. You will be 55 on 12/31/23, so you can contribute up to $8,750 to an HSA for the 2023 tax year – the “normal” limit of $7,750 + additional $1,000 due to your age.

Tax treatment of HSA distributions

HSA distributions used to pay eligible medical expenses of the owner, spouse, or dependents of the HSA are exempt from federal income tax. However, you can build up a balance in the account if contributions plus earnings exceed withdrawals for medical expenses. All earnings are exempt from federal income tax. So if you’re in very good health and receive little or no distributions, you can use an HSA to build a substantial medical expense reserve fund over the years while earning tax-free income throughout. of the course.

If you still have an HSA balance after reaching Medicare eligibility age (usually age 65), you can empty the account for any reason without tax penalty. If you don’t use the withdrawal to cover eligible medical expenses, you’ll owe federal income tax (and possibly state income tax), but the 20% tax penalty that applies. generally applies to unused withdrawals for medical expenses will not apply. There is no tax penalty on withdrawals after disability or death.

Alternatively, you can use your HSA balance to pay for uninsured medical expenses incurred after you reach Medicare eligibility age. If your HSA still has a balance when you leave this cruel orb, your surviving spouse can take over the account tax-free and treat it as their own HSA – provided your surviving spouse is named as the beneficiary of the account. In other cases, the balance at the date of death of the HSA must generally be included in taxable income at that date by the person inheriting the account.

Warning: HSA funds cannot be used to make tax-free reimbursements for medical expenses incurred prior to account opening.

HSA Investment Options and Providers

In some important respects, HSAs are similar to IRAs. Both have the same contribution deadlines, need an account custodian or trustee, and both can theoretically offer the same investment options (stocks, mutual funds, bonds, CDs, etc.) . That said, some HSA administrators may limit your investment choices to very conservative options, which isn’t necessarily a bad thing.

You can find an HSA trustee with an internet search. Some health insurance companies and brokerage firms have pre-arranged agreements with HSA administrators. For example, Vanguard customers can transfer funds to HSAs operated by a partner provider called HealthEquity.

The bottom line

An HSA can work much like an IRA if you can maintain good health and avoid large medical bills. Even though you have to empty the account each year to pay for uninsured health care expenses, the HSA arrangement allows you to make deductible annual contributions and pay for uninsured expenses with pretax dollars. These tax advantages can amount to substantial sums over the years. So if you are eligible for an HSA, starting one and making tax-deductible annual dues is a no-brainer, IMHO.