Utilizing HSAs to Reduce Your Tax Bill

Are you looking for ways to lower your income tax bill? Health savings accounts, or HSAs, are a great tool that can help you shelter income from tax and be a part of your financial plan.

These accounts offer a triple tax advantage; as HSA contributions are tax deductible, HSA earnings grow tax free, and qualified HSA withdrawals are not taxed. This treatment is far superior to the tax deduction allowed for medical expenses due to the limitation on those deductions and the opportunity for tax free growth on the amounts held in your account.

You can claim a tax deduction for contributions you make to your HSA. Below are 6 tips to help you maximize your HSA contributions:

1.) Contribute

Contributing the maximum amount to your HSA allows for you to take advantage of one of the most effective tax savings available. Unlike 401k and IRA savings, HSAs are pretax contributions that are not taxed at any point in the savings or spending process if they are used for qualified medical expenses.

In 2014, you may contribute up to $3,300 to your HSA if you have an individual high deductible health plan (HDHP). In 2014, you may contribute up to $6,550 to your HSA if you have a family HDHP. Additionally, to maximize your HSA contribution, you may contribute to your HSA for the previous year until the tax deadline.

2.) Take Advantage of Catch Up

ContributionsIf you are age 55 or older, you can make additional catch up contributions of up to $1,000 per year. The maximum allowable catch up contribution has increased over the years, offering additional tax savings to those 55 and older.

3.) Let Your Earnings Grow

Investment income within your HSA grows tax free. With an HSA, you will not owe taxes on any interest income or earnings that accrue in your account. Additionally, HSA contributions remain in your account until you use them, allowing your contributions and earnings to continue to grow and compound, tax-free. Distributions from your HSA may be tax free if you use them to pay for qualified medical expenses. However, withdraws for any reason other than to pay for qualified medical expenses will be subject to income tax and may be subject to an additional 20 percent excise tax penalty. To maximize your tax benefits you should never withdraw funds for anything other than qualified medical expenses or you will be subject to these taxes and penalties.

4.) Consider a Qualified HSA Funding Distribution

You may make a qualified HSA funding distribution from your traditional IRA or Roth IRA to your HSA. The distribution must be made directly by the trustee of the IRA to the trustee of the HSA to avoid taxes and penalties. This distribution option can help you cover qualified medical expenses that exceed your HSA balance. However, you can only make one qualified HSA funding distribution in your lifetime.

5.) Know the Laws

Be aware of laws and regulations regarding HSA contributions and the use of HSA funds, specifically maximum annual contribution limits and the list of approved, qualified medical expenses. If you exceed the maximum annual contribution limit or use your HSA to cover non-qualified medical expenses, you could be liable for income taxes and penalties.

6.) Keep Your Receipts

Although it is not necessary to submit your receipts for health care expenditures, you must be able to justify your expenditures if the IRS were to challenge them. If you are not able to justify your expenditures as qualified medical expenses, you may be liable for interest and penalties, in addition to the income tax and 20 percent excise tax penalty.

If you would like assistance in understanding how to maximize the tax benefit from your HSA contributions, please contact your tax advisor at MKS&H.

Article contributed by Jessica Sipple, MKS&H Staff Accountant

About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by advising them regarding their financial, technology and human capital management needs.

Like what you read? Sign-up for our C-Suite Spotlight Program.