3 alternative ways clients can use an HSA
HSAs get hailed as a boon to retirement savers, offering rare triple-tax advantage status to dollars deposited within. But these accounts, offered in tandem with high-deductible health insurance coverage, are far more versatile than they get credit for.
Typically thought of and discussed primarily as a way to help clients meet medical bills today or in their future retirement, HSAs can provide assistance beyond this narrow scope, with funds eligible for use to pay Medicare or COBRA premiums, long-term care, and non-medical expenses — all without jeopardizing that special tax treatment.
Medicare and COBRA premiums
Once clients enroll in Medicare they can no longer contribute to their HSA, but they can do something they could never do on a high-deductible plan: use the money they’ve already stashed in it to cover their premiums.
HSA funds can pay for Medicare Parts A, B and D as well as copays for Part D. Medicare HMO, Medicare Advantage, and MAPD plan premiums are also eligible expenses for reimbursement. However, HSAs cannot help with Medicare Supplement Plan or Medigap premiums, says Paul Fronstin, director of the Employee Benefit Research Institute's health research and education program.
Married couples may run into trouble when they go to reimburse themselves for such premium expenses if the account owner isn’t also the spouse who is going onto Medicare or they are not yet 65, warns Roy Ramthun, founder and president of HSA Consulting Services and a former health care policy advisor for President George W. Bush. That’s because, while HSA’s can normally be used to pay expenses incurred by the account owner’s spouse or dependent, Medicare premiums aren’t considered an eligible expense unless the account holder is 65. This means couples with any age gap need to consider whose name the HSA should be under or each open their own HSA so that the older partner doesn’t have to wait until the younger turns 65 to take advantage of this rule. (Opening two separate HSAs will also allow clients age 55 or older to make duel $1,000 catch-up contributions on top of the usual annual limits.)
Clients who reach Medicare age but opt to delay enrolling because they’re still working can also use their HSA money to pay for their employer-sponsored health care as well as continue funding an HSA. They can do this even if their spouse is on Medicare, as long as they’re on a HDHP.
And finally, clients who lost their jobs this year will likely be relieved by another HSA premium exception. If a person has health care continuation coverage, such as with COBRA, or is collecting unemployment compensation under federal or state law then they can use their HSA to pay the premiums for their health insurance, says Fronstin.
“HSA funds will frequently be used by clients to pay premiums in situations where there are little or no alternatives,” says Justin Rucci, a financial planner at Tustin, California-based Warren Street Wealth Advisors. “In a situation where a client was laid off from work, has a hefty HSA balance, and has expensive COBRA premiums, this could be a prime candidate. Alternatively, a wealthy client with a large HSA balance beyond what they would use for out of pocket medical expenses can be a good candidate for this.”
Like with Medicare and COBRA, HSA funds can be used to cover premiums for purchasing long-term care insurance — if it’s the right policy.
To qualify, a policy must provide coverage for only long-term care services and kick in if you need assistance with at least two daily living activities or if you suffer cognitive impairment.
“Honestly, I don’t know how many policies do not meet these requirements,” says Ramthun. “But there may be some out there and clients will want to make sure it is the right kind or else they’re going to have a bad day when they find out it isn’t.”
If your client is unsure, have them verify with their insurer that their policy is tax-qualified before considering such a move or else they could be on the hook for income tax and a penalty.
The amount a client can take from the HSA to pay the premium depends on their age. For 2019, clients 40 or younger can withdraw $420 annually to pay this expense, but those between 41 and 50 can direct almost double, $790, to their long-term care insurance policy. Those between 51 and 60 can withdraw $1,580; 61 to 70 year-olds can take out $4,220 and people 71 and older can withdraw $5,270. (The IRS has not released the limits for 2020, but they usually rise slightly each year. Ramthun expects the new figures will be out in January.)
Alternatively, clients who do purchase long-term care insurance but pay premiums out of their own pocket each year can save those receipts and then withdraw a sum equal to that annual permitted outlay at any time in the future.
Those who would prefer to go without insurance and self-fund possible long-term care costs can tap HSA assets to pay for such expenses as they occur, allowing them to better take advantage of the potential tax-free growth that comes with saving in an HSA. However, not all long-term care costs are reimbursable, warns Ramthun.
Typically long-term services that are needed to handle daily functions if you’re chronically ill or disabled count, as do those required by a plan of care prescribed by a doctor. But those who require help with more maintenance tasks like laundry or cleaning to stay in their home can’t usually use HSA funds as they aren’t considered a medical service. Nursing home costs can also be tricky for this reason as certain medical care or assistance provided at the facility may be eligible for reimbursement but other associated expenses, like room and board or meals, often are not, even at the highest level of dependent care, says Ramthun.
While clients may have the best intentions to save their HSA funds for future medical expenses in retirement, a year like 2020 can derail such plans. If someone needs additional funds, for, say, living expenses after a job loss or an unexpected car repair, they can withdraw funds from their HSA without triggering taxes or a penalty. The catch? They must have unreimbursed past healthcare expenses.
As long as the client had an open HSA when they incurred the medical expense and hasn’t yet tapped it to cover that cost, an amount equal to that bill can be withdrawn at any time and used for any purpose they want. Clients can claim back funds for expenses dating all the way back to 2004, when HSAs were first introduced, provided they had an account. Receipts should be on hand to prove their story in case the IRS comes checking.
One thing that can trip up clients planning to use this feature is a low or empty current HSA balance. That’s because if the account balance remains at zero for 18 months, the IRS considers the HSA closed and any medical expenses you incurred before that time will no longer be reimbursable, even if you open and fund a new HSA. “
“They essentially lose that original HSA establishment date,” says Ramthun.
Financial institutions may also act before the IRS rule kicks in, closing zero balance accounts after 15 months or earlier, again negating the ability to claim back any previous medical expenses.
Clients who move off high-deductible health plans or change employers and can no longer fund an HSA are most likely to fall victim, Ramthun adds, as a withdrawal for a medical cost or fees may empty the account without them being able to do anything to rectify it.
In desperation, clients may opt to pull more from their HSA than they have in past medical bills, but this move will cost them dearly, triggering income tax and a 20% penalty on the amount unmatched to those unreimbursed health care expenses.
Turning age 65, however, lessens this pain, as withdrawals no longer need to be paired with a medical expense to avoid that 20% tax penalty. Income tax, however, will still be owed on any funds removed for non-healthcare expenses, similar to how distributions from a traditional IRA or 401(k) are treated.