Sacramento Head Start Alumni Association

Build Your Nest Egg with the Hot New Health Savings Accounts

Oct 12, 2004

Build Your Nest Egg with the Hot New Health Savings Accounts

James Shagawat
Baron Financial Group

Special from Bottom Line/Personal


ou can get big tax breaks for medical and long-term-care insurance costs with new health savings accounts (HSAs) created by recent Medicare drug legislation.

Bonus: These accounts also offer a new way to build wealth.

If you have an HSA, you still can contribute to an individual retirement account (IRA), a 401(k) and a flexible spending account (FSA).

LIKE AN IRA -- ONLY BETTER

HSAs are so much like IRAs, they could be called "health-care IRAs." Benefits...

Money grows tax-deferred, potentially for decades.

You can contribute up to $2,600 a year ($5,150 for a family) and deduct the amount from your federal income tax. Taxpayers age 55 and older can contribute an additional $500.

Tax benefits are more generous than those for traditional or Roth IRAs. Contributions are tax deductible, and withdrawals used to pay health-care expenses are not taxed. In comparison, traditional IRAs offer deductible contributions but withdrawals are taxed. Roth IRA withdrawals are tax free, but contributions are not deductible.

Money can be withdrawn for any purpose without penalty after age 65 -- but you will have to pay income tax if expenses are not health-related. Before age 65, if cash is used for other purposes, you'll be hit with income tax and a 10% penalty.

An HSA can be transferred to a spouse or other beneficiary upon the account holder's death. If transferred to a spouse, the account remains an HSA, so no tax is owed. If transferred to another beneficiary, the account is no longer an HSA. The beneficiary must include the fair market value of the assets as of the date of the HSA owner's death in his/her gross income.

An HSA can be established at any financial institution, just like an IRA, although many institutions don't yet offer them because they are so new. (Until HSAs are readily available, keep money in a traditional IRA.) An HSA can invest in stocks, bonds, mutual funds, etc.

Requirements: You must be under age 65 and have health insurance with an annual deductible of at least $1,000 ($2,000 for a family).

Many corporations are expected to introduce high-deductible plans during the next benefits open-enrollment period this fall in order to trim insurance costs. Some firms might use a portion of the money they save to contribute to employees' HSAs -- as they do for 401(k) plans.

IS AN HSA FOR YOU?

You are a good candidate for an HSA if...

You have a high-deductible health plan through your employer.

You are self-employed. The HSA tax write-off can help ease the burden of paying your own medical costs.

You are in a high tax bracket. Affluent people can use HSAs to generate tax-free savings. For maximum tax benefits, let money in an HSA grow for as long as possible and pay deductibles and other medical costs from taxable accounts. An HSA holder is never required to spend the money in the account.

HOW MUCH CAN YOU SAVE?

Here are two examples of health-care costs that can be saved using HSAs.*

Example 1: A single 60-year-old male makes a $2,500 contribution to an HSA for a $2,500 tax deduction.

Taxable income: $65,000

Federal tax rate: 28%

State tax rate: 3%

Gross health insurance policy cost: $1,795 per year (with $2,500 deductible)

Annual tax savings: $775 [(28% + 3%) x $2,500]

Net health insurance cost: $1,020 ($1,795 - $775).

Example 2: A family of four -- parents in their late 40s, two children in high school -- makes a $4,500 contribution for a $4,500 tax deduction.

Taxable income: $125,000

Federal tax rate: 28%

State tax rate: 3%

Gross health insurance policy cost: $3,410 per year (with $4,500 deductible)

Annual tax savings: $1,395 [(28% + 3%) x $4,500]

Net health insurance cost: $2,015 ($3,410 - $1,395).

HSAs vs. FSAs

Some experts now believe that HSAs eventually will replace FSAs because FSAs have some drawbacks...

IRS regulations require that FSA holders forfeit any unused balance at year-end. Participants must plan carefully. With an HSA, unspent dollars grow tax-free.

FSA holders have to provide documentation of medical expenses before being reimbursed for them. This isn't necessary with an HSA. Nevertheless, you should maintain evidence of medical expenses in case of a tax audit.

COMPARING HEALTH PLANS

With health insurers gearing up to offer high-deductible plans to corporations and individuals, it pays to shop around. To compare high-deductible health insurance policies, contact Insure.com, 800-556-9393. Also check www.ehealthinsurance.com.

Before signing up with an insurer, check its consumer complaint history at the National Association of Insurance Commissioner's Web site, www.naic.org. Search under "Consumer Information Source."

*Source: www.ehealthinsurance.com