The Triple Tax Break You May Be Missing: A Health Savings Account

As Tax Day approaches, an underused part of many health care plans could offer a chance to significantly reduce your tax bill.

A health savings account, or H.S.A., can help pay for some medical expenses, if you qualify to have one. And they offer three valuable tax breaks: Money is deposited pretax, can grow tax-free and is not taxed when you spend it, as long as the expenses are eligible.

It is rare for so many tax advantages to be wrapped into one benefit, financial advisers say. “It’s a great deal,” said Neal Van Zutphen, a certified financial planner in Tempe, Ariz., “even if you don’t invest the money.”

There’s a catch, though: The accounts are available only to people with health insurance plans that meet specific criteria, such as a high deductible, which is the amount a person pays for nonpreventive medical care before insurance. For 2020 and 2021, the amount is at least $1,400 for an individual or $2,800 for family coverage.

The high deductibles could make H.S.A.-eligible plans (which are usually labeled as such) unattractive for those with chronic conditions or costly health needs, even if monthly premiums are lower.

But the accounts could also significantly reduce your tax bill.

Tax Day is the deadline for making deductible contributions for 2020 to health savings accounts. This year, the date was pushed back to May 17 because of the pandemic. But the Internal Revenue Service has not confirmed that the contribution deadline also will be delayed, though last year it was.

A person does not have to itemize personal deductions on a tax return to claim the H.S.A. benefit. It is reported with “adjustments” that reduce taxable income. (Two states — California and New Jersey — do tax H.S.A. contributions and capital gains.)

Even though number of H.S.A.s has been growing, experts say that they are underused, and that more could be done to encourage their use. There were 30 million H.S.A.s holding about $82 billion at the end of 2020, according to Devenir, an H.S.A. services firm.

The accounts can pay for a variety of medical and health expenses, including doctor visits, hospital stays, surgery, and vision or dental care. The money can also go toward long-term-care insurance premiums and services.

The federal government’s pandemic relief program expanded what H.S.A.s can pay for, including nonprescription medicine like pain relief and allergy pills, and menstrual products like tampons and pads. (The I.R.S. has a full list of eligible items.)

Some employers match contributions to H.S.A.s as they do retirement savings. But self-employed people and contractors can open them, too.

People often confuse H.S.A.s with other types of health accounts, such as flexible health spending accounts. But unlike F.S.A.s, health savings accounts are portable: If you change jobs or leave the work force, you keep the account. Contribution limits are higher for H.S.A.s, and there is no deadline to spend the cash. Unspent money can be invested for health needs in retirement.

A study published last summer in JAMA Network Open, a journal from the American Medical Association, found that many people with high-deductible insurance didn’t have a health savings account. And more than half who had one had not contributed to it in the previous year. People with health plans bought through a government exchange were more likely to not have an H.S.A., even though the average deductible in the federal marketplace is high enough.

How Has the Pandemic Changed Your Taxes?

Nope. The so-called economic impact payments are not treated as income. In fact, they’re technically an advance on a tax credit, known as the Recovery Rebate Credit. The payments could indirectly affect what you pay in state income taxes in a handful of states, where federal tax is deductible against state taxable income, as our colleague Ann Carrns wrote. Read more.

Mostly.  Unemployment insurance is generally subject to federal as well as state income tax, though there are exceptions (Nine states don’t impose their own income taxes, and another six exempt unemployment payments from taxation, according to the Tax Foundation). But you won’t owe so-called payroll taxes, which pay for Social Security and Medicare. The new relief bill will make the first $10,200 of benefits tax-free if your income is less than $150,000. This applies to 2020 only. (If you’ve already filed your taxes, watch for I.R.S. guidance.) Unlike paychecks from an employer, taxes for unemployment aren’t automatically withheld. Recipients must opt in — and even when they do, federal taxes are withheld only at a flat rate of 10 percent of benefits. While the new tax break will provide a cushion, some people could still owe the I.R.S. or certain states money. Read more.

Probably not, unless you’re self-employed, an independent contractor or a gig worker. The tax law overhaul of late 2019 eliminated the home office deduction for employees from 2018 through 2025. “Employees who receive a paycheck or a W-2 exclusively from an employer are not eligible for the deduction, even if they are currently working from home,” the I.R.S. said. Read more.

Self-employed people can take paid caregiving leave if their child’s school is closed or their usual child care provider is unavailable because of the outbreak. This works similarly to the smaller sick leave credit — 67 percent of average daily earnings (for either 2020 or 2019), up to $200 a day. But the caregiving leave can be taken for 50 days. Read more.

Yes. This year, you can deduct up to $300 for charitable contributions, even if you use the standard deduction. Previously, only people who itemized could claim these deductions. Donations must be made in cash (for these purposes, this includes check, credit card or debit card), and can’t include securities, household items or other property. For 2021, the deduction limit will double to $600 for joint filers. Rules for itemizers became more generous as well. The limit on charitable donations has been suspended, so individuals can contribute up to 100 percent of their adjusted gross income, up from 60 percent. But these donations must be made to public charities in cash; the old rules apply to contributions made to donor-advised funds, for example. Both provisions are available through 2021. Read more.

The findings suggest that health plans, employers and financial advisers could do more to explain how H.S.A.s work, simplify their use and encourage contributions, said an author of the study, Dr. Jeffrey T. Kullgren, associate professor of internal medicine and health management and policy at the University of Michigan.

“Anything that makes it easier would be a good thing,” he said.

H.S.A. providers increasingly are cutting fees and using technology to encourage use. Fidelity Investments this month will test an app that will allow clients with employer H.S.A.s to track account balances, contributions and spending. The app will also let users scan products to check if they are H.S.A.-eligible.

Others are focusing on workers in the gig economy. Starship, a start-up, promotes its accounts through affiliations with ride-hailing and delivery companies. Its app allows workers to automatically invest contributions in low-cost index funds and exchange-traded funds. Because there is no required minimum balance, users are able to invest all of their contributions. But that would also leave no cash available to cover medical costs, unless the investments are sold. Starship sets the default minimum threshold before investing at $2,000, but users can lower it to zero, said Sean Engelking, the company’s chief executive.

Here are some questions and answers about health savings accounts:

How much can I contribute to an H.S.A.?

For 2020, people with individual health coverage were able to contribute up to $3,550, including employer contributions. Those with family coverage could have contributed as much as $7,100. (People older than 55 can contribute an extra $1,000.) For 2021, the limits are $3,600 for individuals and $7,200 for family coverage.

Can I have more than one H.S.A.?

Yes. If you don’t like the investment options offered by your employer’s H.S.A., for example, you can open an H.S.A. with a different provider and transfer funds into it (while keeping the old one open to receive any employer matches). But the total contributions — including any from your employer — can’t exceed the annual limit set by the I.R.S., said Roy Ramthun, president and founder of HSA Consulting Services.

What if I spend my H.S.A. money on ineligible items?

Spending on unqualified care or products is subject to regular income tax, plus a penalty of 20 percent of the amount withdrawn, according to Fidelity. For anyone 65 or older, the penalty goes away, though the money is still subject to regular income tax. Spending on eligible items remains tax-free.

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