Smart Money, Tax Saving with Health Savings Account

Would you open saving account in which doesn’t need to pay income tax?

It’s definitely yes for me. A health savings account (HSA) is a tax-free savings account for U.S. taxpayers who are enrolled in a high-deductible health plan (HDHP). Basically, it is the saving account that you or your employer can deposit money in every year. You can use this account to pay for your medical expenses. For example, you deposited $3,000 in 2015 and you went to see the doctor. You need to pay $1,000 as deductible to the hospital. You withdraw $1,000 from your HSA account to pay the bill. Now, your HSA balance is $2,000 ($3,000-$1,000) that can be used. HSA balance is roll over and accumulated year to year if it is not being used. The good thing is that the money that you deposit in your HSA account each year can be deducted from your income so it will reduce your tax liability.

When you file your tax return each year, you can reduce your income by subtract amount that you deposit to your HSA account that year. It is located in 1040 form, item number 25 (for tax year 2015). The label is “Health savings account deduction” as figure 1 below.

Figure 1: 1040 Form, item 25 (for tax year 2015)

Let’s do the math. Assuming that you are single, earn $50,000 and deposit $3,350 in your HSA account in 2015. Please see figure 2 below for this example. We are going to compare between No HSA and with HSA to see how much we can save. First, you are single so we will use Standard deduction $6,300 (line 2) and Personal Exemption $4,000 (line 3) to make it easier for calculation. The different is at line 4 which is HSA amount; $0 vs. $3,350. Second, we will apply the taxable income equation.

               Taxable income = income – standard deduction – exemptions – HSA 

		No HSA	HSA
1	2015 Income	$50,000.00	$50,000.00
2	Standard deduction	($6,300.00)	($6,300.00)
3	Exemptions	($4,000.00)	($4,000.00)
4	HSA	$0.00	($3,350.00)
5	Taxable income	$39,700.00	$36,350.00
6	Tax	$5,725.00	$4,995.00
7	Tax saving		$730.00

Figure 2: 2015 Tax Calculations

Finally, we will use the taxable income to calculate the total tax. In this example, I used TaxAct and TurboTax online income tax calculator to get the result on line 6. Luckily, both produced the same results. As you can see that you would pay less tax for 2015 if you had HSA. Total saving is $730 (line 7) plus you would have $3,350 extra for your future health expenses.

Things you need to know.

1.      HDHP. You need to have the high-deductible health plan (HDHP) in order to participate in the HSA program. When you purchase health insurance from market place, you need to make sure that you select the plan that eligible for HSA. Mostly, bronze plan is eligible.

2.      There is an annual limit amount that you can deposit to HSA based on your status. For example, the deposit limit for single is $3,350 and family is $6,750 for year 2016. All deposits to an HSA from both employee and employer count toward the annual limit.

For example, year 2016, single:          $3,350 <= employee deposit + employer deposit

3.      If you reach age of 65 or become disabled, you can withdraw money from HSA for non-medical expenses without a 20% penalty. However, you still need to pay income tax for that amount.

4.      Investments: you can use money in your HSA to invest. Investment earnings are not subjected to income tax unless you withdraw for non-medical expenses. This is another advantage for having HSA. Let’s say, you have $10,000 in your HSA. You keep $5,000 in the saving account for your medical expenses and you keep another $5,000 in the investment funds. If your funds are increased in value 10%, you would earn $500. You have $10,500 in total and no tax is paid at the time you earn.

Historical data compiled for single/individual: 2004-2017

Figure 3: Deposit limit, Min deductible, Max out-of-pocket for single since 2004-2017

Historical data compiled for Family: 2004-2017

Figure 4: Deposit limit, Min deductible, Max out-of-pocket for Family since 2004-2017

Based on the charts above, you might notice that the deposit limit increase almost every year for both individual/single and family. IRS adjusts limit based on inflation rate each year which is good for us if we rarely use HSA for medical expenses because we are healthy. Investment profit from this account is tax-free.

This article should give you a basic understanding about HSA; you can read this guidebook link for more detail. It should give you an idea or provide an option for you to manage your hard-earned money.

The information presented hereupon is provided for informational purposes only and should not be interpreted as tax or legal advice. The information presented here has been obtained from IRS publications. Always consult a qualified tax planning advisor.

By Niwech Harnkham, M.S.

Founder and President of EKSPERTSOFT, LLC

www.ekspertsoft.org