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HSA Tax Benefits

HSA plus IRS

Unless you’ve got one of those magical unicorn health insurance plans with no deductible, no copay, a low premium and tons of coverage, it’s easy to feel like your health insurance plan is taking more than it gives. But the good news is that there’s at least one way to start balancing the scales.

If you’ve got a high-deductible health plan (HDHP), then you’re eligible to open a health savings account (HSA). It’s basically a triple tax-free slam dunk. No magic wand or unicorn dust needed! Here’s everything you need to know about the tax benefits that come with an HSA and how to take advantage of them starting right now.

How an HSA Works

Think of an HSA like a savings account you can use to save for qualified medical expenses now and in the future. We’re talking about everything from Band-Aids and body scans to midwives and motion sickness medication. 

But not everyone is eligible for an HSA. There are some basic criteria you have to meet first, but once you do, making contributions is super easy and the tax benefits are immediate.

HSA Eligibility

Three things need to be true for you to open an HSA:

Do you have the right health insurance coverage? You could be saving hundreds!

1. You’re enrolled in an HDHP.

In 2020, that means your health insurance plan has a minimum deductible of $1,400 for single coverage or $2,800 for family. It also means a maximum annual out-of-pocket expense of $6,900 for individuals and $13,800 for families. This includes things like deductibles, copayments and coinsurance—but not your premium.

2. You aren’t enrolled in Medicare.

3. You’re 18 years or older and no one can claim you as a dependent on their tax return.

If all of these are true, you’re in. But hold your horses! Before you start contributing to an HSA, make sure you’re on the right Baby Step.

HSAs in the Baby Steps

While HSAs are a great idea for folks with HDHPs, there’s a right time and place when it comes to making contributions. If you’re in Baby Steps 1 and 2, it is not the time to add money to an HSA. Every penny you can spare should be going toward demolishing your debt. 

But once you reach Baby Steps 3 through 7, feel free to fire up that HSA and start saving, earning and investing—tax-free!

HSA Tax Benefits for 2020

In order for you to take advantage of this tax-advantaged savings account, you’ve got to add some money to the pot. But before you go withdraw a huge chunk of change from the bank, know that there are limits to how much you can contribute to your HSA.

In 2020, the maximum annual HSA contribution you can make as an individual is $3,550. For families, that number goes up to $7,100. If you’re 55 and older (and not enrolled in Medicare), you can also make an annual “catch-up contribution” of $1,000.

But don’t forget, these numbers include employer contributions. You don’t want to exceed these limits, or you’ll get hit with a 6% tax.

  Single Coverage

Family Coverage

HSA Contribution Limit for 2020

(Employee + Employer)

$3,550

$7,100

HSA Catch-Up Contributions for 2020

(Age 55 and Older)

+ $1,000

+ $1,000

 

Whether you contribute $50 or $7,100, here are the three major tax advantages you get to enjoy with an HSA:

1. Tax-Free Contributions

One of the best perks of an HSA is that when you make a contribution, you’re adding money tax-free. That can happen in a couple of ways.

The first is through a pretax payroll deduction. This means your employer drops whatever HSA funds you’ve earmarked to come out of your paycheck straight into your HSA account. Poof! Now you see it, now you don’t. That money goes into your HSA and isn’t counted as income. Therefore, it can’t be taxed. Cha-ching!

But maybe you don’t get your insurance through your employer, or your employer doesn’t route funds on your behalf to your HSA. No problem. Make your contributions as you normally would, and then come tax time, claim those contributions as tax deductions so they aren’t counted as income.

If you’re self-employed, you contribute pretax and it won’t count toward your taxable income.

Heads up, New Jersey and California—you’ll have to pay state income tax on your HSA contributions.

Plus, right now, because of the coronavirus stimulus package passed in Congress, the deadline for making 2019 contributions has been extended from April 15, 2020 to July 15, 2020. Now you have an extra three months to add to your HSA!

2. Tax-Free Growth

Now that your money is sitting pretty in an HSA, here comes tax-free bonus number two: Your money grows tax-free. Remember, an HSA is a health savings account, so it acts like a savings account and earns interest. But unlike a regular savings account where interest earned will be counted as taxable income, your HSA contributions can grow without the tax hit.

Sorry, New Jersey and California, any HSA earnings are considered taxable income.

3. Tax-Free Withdrawals

With an HSA, not only are you setting aside money for current medical expenses but you’re also able to save for future health care costs. Whether it’s this year or 10 years from now, when the time comes to make a withdrawal you can take that money out tax-free as long as it’s for a qualified medical expense.

There’s another perk-within-a-perk here too. Once you turn 65, your HSA will also act like a traditional IRA. You can withdraw funds from your HSA for whatever you’d like, not just qualified medical expenses. Don’t forget though that you’ll pay taxes on those funds when you do.

Once you’re enrolled in Medicare, you won’t be able to contribute to your HSA any longer. But just think, all the contributions you made pre-Medicare will give you the freedom to pay for medical expenses in retirement from your HSA, all tax-free!

Tax Differences Between HSAs vs. FSAs

If you’ve heard of HSAs, then you might also be familiar with FSAs, or Flexible Spending Accounts. Both are like emergency funds for medical expenses, but how they function out in the real world is pretty different. We break down all the need-to-know information about HSAs vs. FSAs here, but let’s take a closer look now at their tax differences.

1. FSA annual contribution limits are lower.

In 2020, you can contribute up to $2,750 into an FSA. Because FSAs are only available through employers, it’s possible your employer could set the limit lower than $2,750. With an HSA, however, an individual can contribute up to $3,550 or $7,100 for a family. The closer you get to those maximum contributions, the less you have to report as taxable income.

2. HSA funds roll over, but FSA funds don’t.

HSAs definitely have a leg up on FSAs here. FSAs are “use it or lose it,” so wave bye-bye to any funds you didn’t use in a calendar year. (You might be able to rollover $500 if your employer provides that option, but that’s the max.)

What’s that got to do with your taxes? Well, because HSA funds roll over, you can continue to grow your account year over year. All those contributions are going in tax-free and growing tax-free. An FSA zeroes out each year with no opportunity to earn tax-free interest.

3. You can’t invest your FSA funds.

One of the lesser known benefits of an HSA is that you can invest those funds into good growth stock mutual funds. Because FSA funds have a 12-month lifespan, you lose the investment opportunity—and the tax benefits—with an FSA. Without the investment piece, choosing an FSA means losing out on tax-free interest and earnings.

Opening an HSA Account Yourself 

Setting up an HSA account is so easy. Like five minutes easy. And if you’re enrolled in an HDHP, it’s a no-brainer. So, if you’re ready to start cashing in on your triple tax-free HSA to give you and your loved ones peace of mind in the future, then open your HSA today!

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Are You Eligible for an HSA? 

Take the Quiz

Are You Eligible for an HSA? 

Find out with our quick quiz! 
Take the Quiz

Are You Eligible for an HSA? 

Find out with our quick quiz! 
Take the Quiz