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HSAs Offer Another Path to Tax Deductions

Christine Benz
Susan Dziubinski

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. Last-minute IRA contributions often get a lot of attention around tax time, but you don't hear much about the fact that you can also contribute to a health savings account for 2018 up to the tax-filing deadline. Joining me to discuss why eligible investors should give HSA contributions a look is Christine Benz, director of personal finance for Morningstar.

Christine, thanks for joining us today.

Christine Benz: Susan, it's great to be here.

Dziubinski: Now, how does contributing to an HSA help reduce your tax bill?

Benz: You will be able to deduct your contribution to a health savings account. And one key thing to know is that you can deduct that contribution regardless of whether or not you are an itemizer. So, even if you are not itemizing your deductions, you will still be able to deduct that HSA contribution and also, it doesn't depend on your income. In contrast with IRA contributions where, in order to be able to deduct that contribution, you have to be below income thresholds. Anyone of any income level can make an HSA contribution provided they are covered by a high-deductible healthcare plan.

Dziubinski: Now, there are other tax benefits to HSAs, correct?

Benz: You receive that deduction or if you are making it through your payroll you will receive--you will be able to make pretax contributions. But you will also be able to enjoy tax-free compounding as long as the money is inside the health savings account. And then when you pull the money out, provided you use the money for qualified healthcare expenditures, you can take tax-free withdrawals. So, the benefits, the tax benefits, are really the greatest if you are able to use non-HSA dollars to pay your healthcare expenses as you incur them and leave the money in the HSA to benefit from the tax-free compounding for the longest possible period of time.

Dziubinski: Can anyone contribute to an HSA or are there particular requirements?

Benz: The big requirement is that you are covered by a high-deductible healthcare plan, what the IRS considers a high-deductible healthcare plan. So, for 2018, for single people covered by a high-deductible plan, the plan had to have a minimum deductible of $1,350. For families covered by a high-deductible plan, the minimum deductible had to be $2,700. So, that's the big requirement. And importantly, if you wanted to make an HSA contribution for the 2018 tax year, you needed to be covered by that high-deductible plan last year and, of course, you needed to have not fully funded that HSA already.

Dziubinski: If you are making an HSA contribution on your own, what are the things you need to consider?

Benz: Morningstar has been doing some work on HSA plans, attempting to shed some light on what had, I think, up until we began to look at them, had been a pretty opaque area. So, the key thing is to take a step back and think about how you will be using that HSA on an ongoing basis.

So, many people use HSAs as they were originally intended: They use them to spend as they go. So, they pull from them to cover healthcare expenses. If that's your plan, if that's how you are using the HSA, you'd want to look for plans for HSAs with low maintenance fees and also good yielding savings vehicles, right, so you want to be able to earn the highest possible yield. If you are using it as a long-term investment vehicle, if your plan is to maybe leave that money undisturbed and actually get that HSA invested in long-term assets, you'd want to focus on all-in costs as well, but you'd also want to take a look at the investment lineup, and that's something that our team has been working on--evaluating HSAs on that basis.

Some people use a hybrid approach, so they might have the best intentions of leaving the money in the HSA undisturbed but occasionally pull from it. In that case, you'd want to look for both low maintenance fees as well as good savings yields as well as good investment options. And one HSA that our team has found looks good across all of these measures is HSA Authority. That was the top-rated HSA when we last looked at various health savings accounts.

Dziubinski: We've also talked in the past about the role that HSAs can play for people who are concerned about how they are going to cover long-term care expenses someday.

Benz: That's right. And so, I think people who are thinking about purchasing some sort of long-term care insurance policy should bear in mind that the HSA can be usable in this context. And so, I think it might help sort of deal with the psychological aspect of purchasing long-term care insurance--not a fun expenditure--but it's important to know that you can withdraw from your HSA to pay premiums up to the IRS' limits. And so, the limits do depend on your age. So, for people who are between ages 51 and 60, which is often prime time for purchasing long-term care policies, you can steer $1,580 in 2019 to cover long-term care insurance premiums. If you are between ages 61 and 70, that jumps up to $4,220 for premiums. So, that's something to keep in mind. I talk to a lot of retirees and pre-retirees; the long-term care issue is very much on their radar. This is something to think about in that context.

Dziubinski: Christine, thank you so much for joining us today. Lots of great food for thought about a pretty exciting new vehicle for people.

Benz: It is, Susan. Thank you so much.

Dziubinski: Thank you. For Morningstar, I'm Susan Dziubinski. Thanks for watching.