08 Aug A Self Directed HSA is an IRA Version 5.0
A “Health Savings Account” (HSA) is one of the most tax efficient and versatile retirement accounts you should own! A Self Directed HSA is an IRA version 5.0. With proper planning, a self directed HSA can literally outperform a 401(k), Traditional IRA, or even a Roth IRA!
What is an HSA
An HSA is a trust account used to pay medical expenses that a high deductible health plan (HDHP) does not pay.
HSA’s Offer Triple Tax Advantages
1. Annual Tax Exemption for Contributions
2. Tax Free growth
3. Tax Free qualified distributions.
HSA holders must follow strict rules for spending HSA funds. Employers that offer HSA programs generally have very little, if any, involvement in HSA distributions.
Owners of HSA accounts have sole discretion for how and when to use HSA funds. The HAS custodian or trustee tracks and reports all HSA activity.
Some distribution rules may apply to or affect employers, this is why we recommend having a personal HSA and not one tied to your employer.
Annual HSA Contributions
Contributions to an HSA are deductible in the year they are made. They are capped by congress and the limits change at their discretion. The annual contributions for 2019 are as follows:
$3,500 Individual – $4,500 after age 55
$7,000 Family – $8,000 after age 55
At age 55 catch up contributions are allowed. The additional amount is $1,000 whether an individual or a family.
Tax Deadline: Contributions can be made up until April 15th for the prior tax year.
What are the eligibility requirements for an HSA?
You can only establish and contribute to an HSA if you are participating in a “High Deductible Health Plan (HDHP). The HDHP will have a lower premium than traditional health insurance policies, but you will be required to pay more out-of-pocket for medical expenses before the insurance company begins to share the cost, i.e. high deductible.
Individuals must meet all of the following IRS-defined criteria in order to be eligible for opening and contributing to an HSA.
Individuals must be covered by a qualified High Deductible Health Plan.
The minimum required deductibles are subject to change whenever congress is in session. For Calendar year 2019 an HDHP cannot provide a deductible less than:
Individual Coverage: $ 1,350.00
Family Coverage: $ 2,700.00
The maximum out-of-pocket expenses (deductibles) are also subject to change by congress. For 2019 the deductibles are capped as follows:
Individual Coverage: $ 6,750.00
Family Coverage: $13,500.00
Individuals cannot be covered by another non-qualified healthcare plan, such as a health plan sponsored by a spouse’s employer, Medicare, or TriCare.
Individuals cannot be claimed as a dependent on another individual’s tax return.
If the individual has a flexible spending account (FSA), participation is restricted to dental, vision, or post-deductible medical expenses.
What is an HSA Distribution
An HSA distribution includes all money an HSA owner takes out of an HSA.
Who Can Make Withdrawals
The HSA owner and anyone they designate can request distributions from an HSA for any purpose. If certain rules are followed, the distribution is not taxable. However, if any portion of a distribution is not used in accordance with HSA rules, that portion is taxable as income to the HSA owner. When an HSA distribution is taxable, it is also subject to a 20 percent penalty unless the HSA owner is over age 65, disabled or deceased.
How are HSA Distributions Administered
All HSA funds must be held by an approved HSA custodian or trustee. Once money is contributed into an HSA, it belongs to you the account owner. The account holder has complete control over how to spend any deposited funds
An employer that contributes funds to an employee’s HSA cannot make a custodian or trustee refund the money, even if the amounts deposited exceed contribution limits. Neither an employer nor an HSA custodian or trustee is required to determine whether HSA distributions are used for qualified medical expenses. This is one of the main features that will distinguish HSAs from Flexible Spending Accounts (FSAs) and Health Reimbursement Arrangements (HRAs).
Employers can choose the custodian or trustee to set up employees’ HSAs, but they cannot restrict employees from making withdrawals or transferring HSA funds to a different HSA. If an employer chooses an HSA that allows employees to access their HSA funds through a health-care restricted debit card, the account funds must also be readily available to the HSA owner through cash withdrawal or other distribution methods. The employer must notify employees about the alternate means of accessing funds. An HSA custodian or trustee can place reasonable administrative restrictions on HSA owner’s distributions, generally limited to setting a minimum dollar amount for single distributions and a maximum number of distributions per month.
The custodian or trustee may also withdraw funds from an HSA to cover its administrative fees, but these amounts are not considered distributions.
When May HSA Distributions Occur
Distributions can be made tax-free for qualified medical expenses, such as the policy deductible and co-pays, as well as dental, vision, or hearing care expenses even if they are not covered by the health insurance.
For more information on qualified medical expenses, review IRS Publication 969.
No Pre-Existing Medical Bills
Your HSA funds cannot be used for expenses incurred prior to the date the HSA was established. In other words, a distribution is taxable (and possibly subject to the 20 percent penalty) if the HSA owner uses it to pay for medical care that was obtained before the HSA existed. State law determines the exact HSA establishment date for this purpose.
For medical expenses incurred after an HSA is established, there is no time limit for when an HSA owner may take a distribution. Similarly, HSA owners are not obligated to take distributions at any time. All unused funds remain in an HSA from year to year and may be used for qualified medical expenses incurred in the future.
An HSA is an extremely tax-efficient plan that allows anyone to make tax-deductible contributions. When the rules are followed all distributions are tax-free. Such as when we reimburse ourselves for qualified medical expenses.
After the HSA is established you can defer reimbursement for any period of time as long as the medical expense was incurred during the lifetime of the HSA. This option always you to hold your distributions while the account value is increasing.
Early Distribution Penalty
Any withdrawal is referred to as a distribution. There are two types of distributions you can make. These are qualified and non-qualified.
Any “Distribution” for anything other than qualified medical expenses is considered a non-qualified distribution. Non qualified distributions are both taxable at your current income bracket AND will be subject to an additional 20% early withdrawal penalty by the IRS
The early distribution penalty ceases at age at age 65 when the 20% penalty goes away and you can be enrolled in Medicare.
HSA Eligible Expenses:
- Acupuncture
- Alcoholism and Drug Addiction treatment
- Ambulance services
- Artificial teeth
- Bandages
- Birth control and contraceptive devices
- Body scan (electronic)
- Braille reading material
- Breast feeding supplies/lactation expenses
- Capital expenses (home improvements that accommodate a disabled person)
- Chiropractor
- COBRA coverage
- Communication equipment for the deaf or speech impaired
- Contact lenses and eyeglasses
- Crutches (purchased or rented)
- Dental treatments (most)
- Diagnostic devices (blood sugar monitors, blood pressure monitors, etc)
- Disabled dependent expenses for medical care
- Eye exams
- Eye surgery
- Fertility treatments
- Guide dog or other service animals
- Hearing aid expenses (batteries, repairs, and maintenance)
- Home for the Intellectually and Developmentally Disabled
- Hospital services (including meals and lodging)
- Insurance Premiums (if receiving unemployment benefits)
- Laboratory fees (associated with medical care)
- Lead-based paint removal
- Long-term care and services for chronically ill individual
- Medical Conference expenses (if related to personal chronic illness)
- Medicare B and D premiums
- Nursing home and services
- Organ transplants
- Oxygen and oxygen equipment
- Physical examination, Annual
- Pregnancy test kits
- Prescription drugs and medicine (excluding insulin)
- Prosthesis (including artificial limbs and breast reconstruction surgery)
- Psychiatric care
- Psychoanalysis
- Psychologist
- Smoking cessation (OTC medicines and treatment plans)
- Special education
- Therapy
- Transportation expenses for medical treatments and services
- Vehicular expenses (for operational and design costs that accommodate a disabled person)
- Weight loss program (requires physician’s diagnosis)
- Wigs (for hair loss due to disease or medical treatment)
- Wheelchairs
- X-ray
NOT Eligible:
- Babysitting, child care or nursing for healthy baby
- Controlled substances (Illegal under federal law, such as marijuana, laetrile, etc)
- Cosmetic surgery not related to a deformity or illness (i.e., facelift, liposuction, etc)
- Dancing lessons
- Diaper services (unless related to effects of disease)
- Electrolysis
- Funeral expenses
- Future medical care
- Hair transplant or removal
- Health club dues
- Household help
- Illegal operations and treatments
- Maternity clothes
- Medicines and Pharmaceuticals from another country
- Nonprescription drugs and medicine
- Nutritional supplements
- Swimming lessons
- Teeth whitening
- Veterinary fees (unless for service animal)
Medicare Warning
Once eligible to enroll in Medicare you are no longer eligible to contribute to an HSA. You need to apply for Medicare.
There are only certain times when you can enroll in Medicare. The first time you can enroll is called your “Initial Enrollment Period” and lasts seven (7) months. The basic rules are as follows:
- Begins 3 months before the month you turn 65
- Includes the month you turn 65
- Ends 3 months after the month you turn 65
Medicare Part A late-enrollment penalty
If you don’t enroll when you’re first eligible for Medicare, you can be subject to a late-enrollment penalty, which is added to the Medicare Part A premium. The penalty is 10% of your monthly premium, and it applies regardless of the length of the delay.
Medicare Part B late-enrollment penalty
If you fail to sign up for Part B when you’re first eligible, you’ll have to pay a late enrollment penalty. You’ll have to pay this penalty for as long as you have Part B. Your monthly premium for Part B may go up 10% of the standard premium for each full 12-month period that you could have had Part B, but didn’t sign up for it. Also, you may have to wait until the General Enrollment Period (from January 1 to March 31) to enroll in Part B. Coverage will start July 1 of that year.
There are situations that will waive this penalty that allow you to sign up for Part B during a Special Enrollment Period.
If you have limited income and resources, your state may help you pay for Part A or Part B. Maybe even both.
HSA Retirement Income Strategy Part 1
For this strategy to work, you must be able to pay out-of-pocket medical expenses from your cash flow or sources other than your HSA.
Below is an example of the impact of this strategy for George, a 40-year old with a HDHP that covers his family. George plans to retire at age 70.
George can start drawing social security retirement benefits as early as age 62 or as late as age 70. However, George will be eligible to enroll in Medicare at age 65. Once eligible for Medicare he must stop making HSA contributions at that time.
Maximizing this plan George makes tax-deductible contributions of $7,000 each year to his HSA for the first 15years. He then adds an additional $1,000 in catch up contributions for the next 10 years.
15 x $7,000 = $105,000
10 x $8,000 = $ 80,000
Total $185,000
HSA Retirement Income Strategy Part 2
Facing no health emergency George does not request reimbursement from the HSA for his family’s medical expenses, but maintains all receipts. If we assume that out-of-pocket qualified medical expenses average $6,000 per year, the 25-year total would be $150,000.
George invests his tax-deductible contributions in his HSA, using a long-term growth strategy. If George averages a 10 percent per year return with his HSA he has an account balance of over $825,000 after 25 years.
At age 66.5, George retires with approximately $825,000 in his HSA and begins making tax-free withdrawals as reimbursement for the $150,000.00 of medical expenses paid out-of-pocket during the last 25 years.
The Pay Off
The remaining $675,000 can be withdrawn penalty-free, but taxable as ordinary income (similar to a distribution from an IRA). However, starting at age 65, in addition to qualified medical expenses that may be incurred, HSA funds can be used tax and penalty-free to pay for health insurance premiums; including Medicare Part B and long-term care coverage. If we assume a $10,000 per year distribution, the HSA could fund George’s medical expenses tax-free into his late 90s.
Better than an IRA!
Assuming a 25% tax bracket, the ability to withdrawal $675,000 tax-free in retirement could save George’s family $120,000 in taxes! If this money was inside a Traditional IRA instead of an HSA, the entire $675,000 would be taxable as ordinary income, assuming all contributions were tax-deductible.
No Required Minimum Distribution
There is no Required Minimum Distribution (RMD) on HSAs as with Traditional IRAs. This allows you to withdraw as little or as much as needed to pay insurance premiums or qualified medical expenses regardless of your age. The longer you can allow the HSA funds to grow tax-free, the greater your benefit.
No other investment account has tax-deductible contributions, tax-free growth, and tax-free distributions. If you are eligible to establish an HAS you can make this retirement income strategy work for you! Just save and invest through your HSA, pay out-of-pocket for your current medical expenses, and maintain your receipts.
A Self Directed HSA is an IRA Version 5.0
Here is the capstone on this great little investment. You can have a self directed HSA. This means you can invest in Stocks, Bonds, Precious Metals and even REAL ESTATE! Not every HSA Trustee will do this so you need to shop around. Many will allow stock and bond investments but not all will allow real estate. Before you settle on a Trustee ask what their fees are.
You HSA account can be free to set up with a company like Lively. But they will not allow real estate investment. You will need to shop around. Once you get into real estate investment you will end up paying some standard fees to the Trustee that will cost you $1,200 a year or so. If the deal is right, It will be worth it.
Your Self Directed HSA can earn up to a 15% annual return ALL TAX FREE!
Summary
By taking advantage of IRS rules for HSAs and properly planning, you could change your financial future! An improved future means greater flexibility and choices during retirement.
Disclaimer: This strategy works based on current tax laws and provisions as published in 2019. These laws and provisions can change as often as politicians change their socks. Before implementing this strategy, you should consult with a financial planner or tax advisor.
This article is an excerpt from George’s upcoming new book “The Investors Survival Guide” Coming soon.
Good Luck and Good Investing
George N. Skidis, Jr.
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