Health savings accounts (HSAs) provide a powerful tax savings tool for clients looking to reduce current taxable income while also potentially building a sizable nest egg for postretirement health-related expenses.

Unlike typical retirement savings vehicles, HSAs provide three key tax benefits—pre-tax contributions, tax-free earnings and tax-free withdrawals.  Because of this, eligible clients are understandably eager to maximize their annual HSA contributions.  Although the annual HSA contribution limits are relatively low, several little known tips and tricks can allow certain clients to supersize their HSAs for optimal growth potential—especially for clients with adult children covered by a family health plan.

HSA Contribution and Eligibility Rules

All clients are eligible to contribute to an HSA if they are covered by a high deductible health plan (HDHP) and are not enrolled in Medicare or additional health coverage in addition to the HDHP (such as a spouse’s employer-sponsored health plan). If the client contributes to an HSA, he or she cannot also contribute to a flexible spending account (FSA) or health reimbursement arrangement (HRA), except in the case of limited purpose accounts that are specifically earmarked for certain expenses (such as dental or vision FSAs).

In 2018, clients can contribute up to $3,450 to an HSA if the HDHP coverage is individual coverage, and up to $6,900 if the client’s coverage is family coverage. Clients age 55 and up are also eligible to make a $1,000 per year catch-up contribution. HSA contributions do not expire each year—they can be rolled over to take advantage of compounded tax-free growth over time, and even used as a retirement savings vehicle for those lucky enough to escape significant health-related expenses.

HSA funds can be withdrawn after age 65 for any reason without penalty, although a 20 percent penalty applies to funds withdrawn before age 65 that are not used to pay qualified medical expenses. If funds withdrawn after age 65 are not used to pay for qualified medical expenses, they are also taxed at the client’s ordinary income tax rates. However, the medical expenses do not have to be incurred in the year of withdrawal in order to be qualified. If the client has saved his or her receipts for previously incurred medical expenses, he or she will be entitled to a tax-free HSA distribution.

Supersizing the Annual HSA Contribution

It is important to remember that the client can maintain more than one HSA if he or she is otherwise eligible to establish an HSA. This gives clients the option of shopping around for the most advantageous HSA, so that the client is not limited to the employer’s chosen HSA, and is also valuable for maximizing the contribution limits for married couples.

While the annual contribution limits apply to all of the client’s HSAs, the client is generally only able to make one $1,000 catch-up contribution to any given HSA each year.  If both the client and his or her spouse are over age 55, they can establish a second HSA so that each spouse is able to make a $1,000 catch-up contribution.

Clients with adult children that are still covered under their HDHP family coverage, but not claimed as dependents, may be able to double their annual HSA contribution. Under the rules as currently in effect, the adult child is permitted to open his or her own HSA and contribute up to the $6,900 annual maximum for family HDHP coverage without reducing the client’s own annual HSA contribution limit.

In fact, if the child is no longer the client’s tax dependent (children can only be claimed as dependents up to age 19, or age 24 if the child is a full-time student), the client can no longer use his or her HSA to fund the child’s medical expenses on a tax-free basis.  For many clients, this means that adult children up to age 26 can contribute an additional $6,900 to an HSA for several years before converting to their own health coverage.

Importantly, the adult child is able to fund an HSA with current pre-tax dollars and allow those funds to grow over time, to spend on his or her own future medical expenses.  The law does not require that the individual be enrolled in an HDHP when the HSA funds are eventually withdrawn and spent—the HDHP requirement applies only for contribution eligibility purposes—meaning that the client’s adult child could use those funds in the future regardless of his or her future health coverage.

Conclusion

It is important for clients to remember that the IRS has not directly approved these strategies for maximizing annual HSA contributions, meaning that clients should be on the lookout for any future IRS guidance that may indicate disapproval.

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