Tag Archives: HSA

The HSA – an Unemployment Safety Net

What if you lost your job tomorrow?  Just the thought of unemployment makes most people cringe.  Besides wrecking havoc on your finances, unemployment causes emotional stress and discomfort.  For the vast majority, their employer is their single biggest source of income.

Dealing with a job loss is easier if you have prepared.  As you will see, there are ways an HSA can help you during an unemployment spell.  Hopefully you are in the planning stages now and can take action.  If you are eligible but haven’t opened an HSA yet, it might be a good time to take 5 minutes to do so.

HSA contributions can benefit you in the following ways during unemployment:

Pay for Health Insurance Premiums
If you are receiving state or federal unemployment aid, you can use your HSA to pay for your health care premiums.  Yes, you read that correctly: while unemployed your health insurance premium is considered a qualified medical expense.  As you probably know, this is not the case when you are employed.

A good strategy is to build your HSA so that the account could cover 6 months of health insurance after a job loss.  There are a number of benefits to this.  For one, you continue coverage that limits your total financial liability– an important part of protecting your assets.  Moreover, you will not need to write a check for health insurance each month; you simply use your HSA funds.  This definitely helps with cash flow as money will be tight.

Thirdly, it is great piece of mind to know that no matter what happens, you can cover X months worth of health care premiums with your HSA.  You have a plan and have cash reserves to get through the worst of it.  Once your situation brightens, you can rebuild your HSA fund.

Tax Free Cash Withdrawal
Your HSA can also function as a backup emergency fund, allowing you to withdraw tax-free cash in times of need.  You can only do this by reimbursing yourself for previous Qualified Medical Expense (QME) paid out of pocket.  I call this strategy using your HSA as an ATM. The way it works is this: if you incur a QME and elect to pay it out of pocket (i.e. not with your HSA), you can reimburse yourself for it from your HSA at any time in the future.  This simply involves transferring money from your HSA to your checking account in the amount of the initial QME.  For example, if you incur a $50 expense for a doctor visit, and you pay for it in cash, you are allowed to transfer $50 from your HSA to your checking account in the future.  This functionally makes the purchase tax-free, and these credits can be carried forward indefinitely.

Why would one want to carry forward Unreimbursed QME?  For one, you are allowing your HSA to compound and grow.  Due to the contribution limitations, each dollar in your HSA is somewhat valuable.  Paying medical expenses out of pocket protects your HSA, allowing it to grow from the highest possible base.

Additionally, carrying forward Unreimbursed QME allows you access to cash when needed.  If an emergency occurs, you can cash in your Unreimbursed QME credits for cash.  This is not the most ideal investment strategy, as you are reducing your principal, but sometimes emergencies require this action.  This is an advantage over accounts such as 401(k) that have a penalty for most cash withdrawals,

Cash Withdrawal w/ tax and penalty
This option is the most painful of the three, but it is still an option.  Perhaps you do not have any UQME with which to reimburse yourself.  At any time, you may make a non-qualified withdrawal from your HSA to pay for anything you want.  Basically, being non-qualified means the expense is not a qualified medical expense.  You simply ‘undo’ or take back your HSA contribution.

However, this comes at a (steep) price.  A non-qualified withdrawal invokes the following:

    1. Tax Man – This amount withdrawn is added to your current year’s gross income, which means it will be taxed.  Initially, you contributed tax free, but since you will be using this money for non qualified purchases, you must now pay tax on this.  For example, if your tax rate is 20% and you withdraw $500, you owe $100 in taxes.
    2. Penalty – Secondly, there is a 20% penalty for non-qualified withdrawals.  This amount is due to the IRS come tax time, and it is not fun.  Back to the prior example, besides the $100 in taxes, there is also a $100 penalty due.  Note:  if you are over 65, this penalty does not apply to you.  That is why an HSA is a great long term savings vehicle for the young, as you only owe income taxes on non-qualified withdrawals in your golden years.

The math shows why this option is so poor.  In our example, a $500 non-qualified withdrawal results in only $300 in your pocket.  You give away a huge percentage of your hard earned money to the government in this maneuver.  But sometimes you have no other option.

If you are at risk of having to make a non-qualified withdrawal during normal (employed) times, perhaps you are being too aggressive with your contributions.  One suggestion would be to park your HSA contributions in your emergency fund before contributing to your HSA.  Here, your money is much more liquid and you avoid penalty for withdrawing it.  At the end of the tax year, once any possible emergencies or costs have arisen, you can make a lump sum transfer to your HSA for that year’s contribution.  Contributing late in the year is far better than a 40% hit.

Conclusion
Having both a strong HSA balance and unreimbursed QME credits puts you in an advantaged financial position.  During a spell of unemployment, these provide cover for 1) insurance premiums and 2) random cash needs.  I make it one of my goals to pay all of my QME out of pocket so I can pull tax-free cash later.    This is an excellent safety net for an unexpected job loss.

In the worst case, you are prepared for difficult times.  In the best case, you have more in your HSA to compound and grow.  Get strategic with your HSA to better prepare for your future.

 


Using your HSA as an ATM

We already know that a health savings account is a terrific savings vehicle because it is triple tax advantaged, which allows you to pay for medical care with tax free dollars.  We also know that your HSA is yours forever, and that you can invest and grow your savings for long periods of time.  This presents the opportunity – given diligent savings and investment – to grow your HSA into a certified nest egg, for either medical care or retirement.

But there is another major advantage that can help you along the way.  You can design your HSA so that you can pull tax free cash from it at any time.  In this way, it acts as your own personal ATM.

Of course, there is no free lunch.  To pull money out of your HSA tax and penalty free, you must do so by reimbursing yourself for previous qualified medical expenses that you paid out of pocket.  This means that at some point in the past, you simply paid for QME out of pocket (credit card, cash, check) instead of using your HSA debit card or check.  Any QME paid out of pocket can be reimbursed from your HSA at any time, tomorrow or in 30 years.

As a simple example, suppose I go to the doctor and pay the $45 copay out of pocket. Since this is a qualified medical expense, I am entitled to reimburse myself from my HSA at any time.  This reimbursement is simply a transfer of $45 from my HSA to my checking account.  No paperwork, no taxes, no mess.  Just a simple transfer.  Tracking this by keeping proper records ensures you maximize your tax free withdrawals and don’t make mistakes.

Unreimbursed QME Credits
You can begin to see the advantage here.  The more QME I pay out of pocket now, the more I can reimburse myself for in the future.  Depending on how often I do this, I can accumulate a fair amount of unpaid reimbursements.  $25 here, $45 there, $100 the following month.  Eventually, I have a lot of cash in my HSA that I am entitled to draw from for reimbursement.

I have termed these credits Unreimbursed QME (creative, I know).  These represent amounts that I can pull from my HSA, tax free, at any time for reimbursement.  While I wouldn’t reimburse myself to purchase baseball tickets, it does serve as a backup emergency fund should such an event arise.  It is nice to have this available should I need it.  Of course, I would rather keep cash in my HSA so it can grow, tax free.

Unreimbursed QME goes back to the essence of saving and personal financial: sacrificing consumption today to enjoy a better tomorrow.

The Benefits of UQME
Paying medical expenses out of pocket isn’t necessarily fun, as it takes from my monthly budget.  At the same time, one of my goals is to pay for as much QME out of pocket as possible.  Why is this?  There are three reasons:

  1. My HSA is one of my savings accounts, and I aim to protect it.  I am much happier spending $45 out of pocket than reducing my HSA by $45.  I want that account to grow, and you can only contribute so much each year.  In my monthly budget, I have a line for HSA contributions (savings) and a line for random medical (expense).  This prevents small medical spending from chipping away at my HSA.
  2. Speaking of growing, there is a huge benefit to allowing your HSA to grow and compound.  Spending it ‘early’ reduces the amount that can compound, which limits the potential growth of the fund.  You need your money working for you for as long as possible. For example, it would be nice to keep that $100 in your HSA, invest it for 7 years, allowing it to double. Then, you can reimburse yourself with ‘the house’s’ money.
  3. Moreover, I view the UQME as a safety net.  I like the option of being able to pull cash from the HSA if I need it, with no tax implications.

Thus, whenever I pay QME out of pocket I feel good as I am protecting my HSA, letting it grow, and establishing a ‘line of credit’ that I can pull from at any time.  Hopefully I won’t need it, but it is nice to know that it is there.

I bet you can’t do that with your copays on your ‘other’ health insurance plan.

 


What are Qualified Medical Expenses?

So you did a lot of research, enrolled in an HSA compatible HDHP, and have even been contributing regularly to your HSA. You have been saving and even investing your funds. Now you need to spend some of it on medical care. What expenses qualify, and can I use my HSA?

First off, we know that purchases of Qualified Medical Expenses (QME) using HSA funds result in no tax being levied on the withdrawal. This is the final step to achieving tax-free medical spending using the Triple Tax Advantage.

However, it is important to understand what expenses are considered qualified.  Doing so allows you to plan your health care spending and maximize the value of those dollars.  By educating yourself, you reduce the risk of incorrectly spending HSA funds.  Accidentally spending your HSA on non-qualified expenses could cause you to file your taxes incorrectly.  This may result in an unexpected tax payment or penalties being due.

Never fear, understanding QME is quite simple. Their scope can be defined by the following:

Who can QME be spent on?

The short answer is you, your spouse, and any dependents you can claim on your taxes.  Even if your spouse or your dependents have their own HSA account, you can still pay for their medical care.

When does QME spending occur?

To be considered qualified, expenses must occur after you have established an HSA.  This means you have opened and contributed to an HSA.  You cannot establish an HSA until the first day of the month following your enrollment in a qualified HDHP.  State laws may determine when your HSA account is officially established.

The lesson here is to setup and contribute to your HSA before you need it.  There is no better time than now as you can complete this in a few minutes.

What is considered a QME?

The IRS has been very lenient with items that are considered QME.  If your expense is remotely medical and reasonable, it seems like it is covered.  This serves as further incentive to participate in HSA accounts.

Here is my unofficial shortlist:

  • Qualified:  anything billed by a doctor/hospital/urgent care, optometrist, chiropractor, dental clinic (excluding cosmetic); prescriptions, and personal medical devises such as contacts, glasses, hearing aids, prosthesis
  • NOT Qualified: Insurance premiums, cosmetic surgery, personal use items (i.e. toothbrush), weight loss programs, health club memberships.  (Note: there are some other funny ones in there, like hair transplant.  At least someone asked; closed mouth doesn’t get fed).

IRS Publication 502 provides a very thorough breakdown of what is considered QME.  If you are unsure of whether an expense is qualified, check that list.

The opening paragraphs provide a good definition and meaning of the term.

Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.

Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They do not include expenses that are merely beneficial to general health, such as vitamins or a vacation.

How can I pay for my QME?

You can pretty much pay for your QME however you want – the key is in good record keeping.  However, here are the two main options and how they are handled.

  • Pay using your HSA –  when you incur a medical expense, you can pay for it directly out of your HSA.  This can be in the form of a debit card or check.  HSA Bank, who is my HSA custodian, provides free debit cards but charges a small fee for checks.  This method requires very little record keeping as the transaction is complete.
  • Pay out of pocket – you can instead opt to pay for your expenses out of pocket and reimburse yourself at the time of your choosing.  The advantage here is the ‘at a time of your choosing’.  This can be that same day or 40 years in the future.  Consider how valuable that $45 visit will be in 40 years earning 5% per year (answer: $673).  Paying out of pocket allows you to build up unreimbursed QME credits.  I call this a backup emergency fundas you can pull money – tax free – from the HSA in a pinch.Either way, make sure you save your receipt and backup a copy when paying out of pocket.  Proper record keeping is key for surviving an audit and reconciling your future HSA reimbursement.