By: Randall A. Denha, J.D., LL.M.*
Obamacare’s Affordable Care Act has been a hot topic in the news so you may be thinking about various health care insurance plans at this time. One arrangement that has been soaring in popularity in recent years has been the pairing of a high-deductible health plan (HDHP) with a Health Savings Account (HSA). The good news is that not only is an HSA a viable option to reduce health care costs, but it also can be beneficial to your estate plan because HSA funds grow on a tax-deferred basis.
How does it work?
An HSA is a tax-exempt account funded with pretax dollars. Like an IRA or 401(k) plan, contributions may be made by employers, employees or both.
An HSA must be coupled with a high-deductible health plan (HDHP), however. For 2014, to qualify as an HDHP, a plan must have a minimum deductible of $1,250 ($2,500 for family coverage) and a $6,350 cap on out-of-pocket expenses ($12,700 for family coverage).
Even if you have HDHP coverage, you generally won’t be eligible to contribute to an HSA if you’re also covered by any non-HDHP health insurance (such as a spouse’s plan) or if you’re enrolled in Medicare.
For 2014, the maximum HSA contribution is $3,300 ($6,550 for family coverage). If you’re age 55 or older, you can make additional “catch-up” contributions of up to $1,000.
What are the benefits?
HSAs provide several important benefits. First, contributions you make can reduce your income tax liability.
Second, they allow you to withdraw funds tax-free to pay for qualified medical expenses. Withdrawals for other purposes are subject to income tax and, if made before age 65, a 20% penalty.
Third, unused funds may be carried over from year to year, continuing to grow tax-deferred. Essentially, to the extent you don’t need the funds for medical expenses or for other expenses before age 65, an HSA serves as a supplemental IRA.
How can an HSA benefit an estate plan?
Like an IRA or a 401(k) account, unused HSA balances can supplement your retirement income or continue growing on a tax-deferred basis for your family. Unlike most other retirement savings vehicles, however, there are no required minimum distributions from HSAs.
It’s important to carefully consider an HSA’s beneficiary designation. When you die, any remaining HSA balance becomes the beneficiary’s property. If the beneficiary is your spouse, your HSA becomes his or her HSA and is taxable only to the extent he or she makes nonqualified withdrawals.
If the beneficiary is someone other than your spouse, however, the account no longer will qualify as an HSA, and the beneficiary must include the account’s fair market value in his or her gross income. (However, the beneficiary will be able to deduct any of your qualified medical expenses paid with the funds from your HSA within one year after your death.)
This differs from an IRA, where a nonspouse beneficiary can spread RMDs over his or her lifetime. So, if you’re age 65 or older and need to take distributions to pay non-medical expenses (or for other purposes), you may want to consider whether it makes more sense to withdraw from:
- Your IRA — preserving your HSA so tax-free funds will be available for your own (or your spouse’s or dependents’) future medical expenses, or
- Your HSA — preserving your IRA’s ability to generate tax-deferred growth for your heirs.
The answer will depend on a variety of factors, such as your age and health, the size of each account, and the beneficiary’s age, health and relationship to you.
Ask your advisor
HSAs can be a beneficial option for many people, especially for young and healthy individuals. In addition to the savings on health care, HSAs offer a tax-advantaged option that provides estate planning benefits.
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*Randall A. Denha, j.d,, ll.m., principal and founder of the law firm of Denha & Associates, PLLC with offices in Birmingham, MI and West Bloomfield, MI. Mr. Denha continues to be recognized as a “Super Lawyer” by Michigan Super Lawyers in the areas of Trusts and Estates; a “Top Lawyer” by D Business Magazine in the areas of Estate Planning and Tax Law; a Five Star Wealth Planning Professional and a New York Times Top Attorney in Michigan. Mr. Denha can be reached at 248-265-4100 or by email at email@example.com