There were a lot of HSA questions. Here are some answers.

A growing number of people are letting their health savings accounts grow tax-free for retirement.

  • By Anne Tergesen and Julia Carpenter,
  • The Wall Street Journal
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Health savings accounts, or HSAs, allow individuals to set aside money in tax-advantaged accounts to pay for medical expenses tax-free.

While many use the money they contribute to these accounts to cover current medical bills, a growing number are paying those bills out-of-pocket to let their HSAs grow tax-free for retirement, when medical costs can be high.

The first year of your HSA

If you know what to expect the first year of your Health Savings Account, the transition may be a lot less daunting.

Following our recent article on HSAs, we received dozens of questions from readers. Here are responses.

The HSA vs. the 401(k)

Q: What are the tax advantages of HSAs, and when do you risk losing them?

A: With an HSA, you can generally contribute money without paying federal or state income or payroll taxes. The money grows tax-free and, if used for medical expenses, can be withdrawn tax-free. With a traditional 401(k) or IRA, in contrast, withdrawals are subject to income tax.

Some states don’t honor all the HSA’s tax advantages. For California and New Jersey residents, contributions aren’t deductible from state income taxes. New Hampshire and Tennessee may tax some earnings.

You can use your HSA for nonmedical expenses, but you will owe income tax on those withdrawals—and a 20% penalty if you are younger than 65.

The fine print

Q: Are HSAs available only to those in high-deductible plans?

A: Yes. But “not all high deductible plans are HSA-qualified,” said Roy Ramthun, a consultant who specializes in high-deductible plans and HSAs. He recommends asking your employer or insurer.

Q: What qualified medical expenses can I use my HSA money for?

A: To withdraw money tax-free from an HSA, you have to use it for qualified expenses incurred by you or your spouse or dependents. Those can include not just medical bills but also dental and vision-care expenses and premiums under Cobra and for all types of Medicare coverage (except Medigap). It also includes a portion of long-term-care insurance premiums and over-the-counter medications you have a prescription for. To check on allowed expenses, see IRS Publication 502.

Q: Can retirees contribute to an HSA before they qualify for Medicare?

A: If you have an HSA-qualified high deductible health plan, you can contribute to an HSA whether you are working or not, Mr. Ramthun said. (Be sure your spouse doesn’t have an account, such as a flexible-spending account, or FSA, that might disqualify you from contributing to an HSA.)

Q: Do medical expenses have to be reimbursed in the year they are incurred?

A: No. The biggest payoff with an HSA comes when the money isn’t used for current medical bills and instead compounds over time.

HSA owners with receipts for unreimbursed medical expenses can tap their accounts tax-free—up to the total on the receipts—to supplement income in years in which taking withdrawals from other accounts would push them into a higher tax bracket or expose them to higher Medicare premiums.

Q: Do I have to save my receipts?

A: If the Internal Revenue Service audits you, you will need receipts to prove HSA withdrawals covered medical expenses. Without proof, the IRS may impose income tax on distributions—and a 20% penalty if you are younger than 65.

Q: Can you reimburse yourself from an HSA for medical expenditures that were deducted on a tax return?

A: No. “That’s double dipping,” said Ed Slott, an IRA specialist who runs his own consulting company in Rockville Centre, N.Y.

Managing the account

Q: Our bank doesn’t offer investment options. Can you provide a list of companies that do?

If you don’t like your options, you can transfer your HSA’s balance tax-free to a new account. Morningstar’s 2019 report on HSAs and Devenir Group LLC’s can help you research offerings. Most HSAs impose account maintenance fees. (Some employers cover them.) Account owners must also pay mutual-fund expenses, so shop for low cost options.

Q: How do I transfer an HSA from a former job?

A: If you leave a job, you can leave your HSA behind. If you want to continue to contribute, you can do so on an after-tax basis and claim a deduction on your tax returns. But if your new employer makes a contribution to its workers’ HSAs or you want to make pretax payroll contributions, you’ll have to establish a new account.

Transferring money from an old to a new HSA can make sense if you want to keep all the money in one place or the new account’s fees or investment options are better. Contact the administrators of the old and new accounts and set up a “trustee-to-trustee transfer.”

Q: How do I track down an HSA from former job?

A: First, search for statements or try to access the account online. If that doesn’t work, contact your former employer to find the administrator it used or check your past tax returns for either a 1099-SA or a 5498-SA.

Q: With HSAs, whatever is left at year-end is retained by the account owner. But this has never been the case for me. What am I missing?

A: You may have had either an FSA or a health reimbursement account (HRA), but not an HSA. As with an HSA, the FSA allows you to contribute pretax money for health-care expenses. But you generally have to spend the money by a set annual deadline or forfeit the remaining balance. (Some employers allow workers to carry over as much as $500 from one year to the next.) With an HRA, the employer is the account owner and decides whether employees can roll money over from year to year or take the account with them when they leave.

For all the couples out there

Q: Can one spouse choose a high deductible plan with an HSA while the other selects conventional coverage?

A: Yes, but it’s important to “make sure the two plans don’t create a conflict that disqualifies” the spouse with the HSA from contributing to it, Mr. Ramthun said. That can happen if one spouse has conventional coverage that covers the other spouse or signs up for an FSA or HRA. Like an HSA, both offer tax benefits.

“If I have an HSA and my spouse signs up at her job for an FSA, in virtually 100% of the cases, that FSA is going to cancel the whole family’s HSA eligibility,” said Mr. Ramthun. Why? “The IRS assumes the FSA is available to all family members unless the employer’s plan documents specifically state otherwise.”

Q: Is $7,100 the total a household can contribute next year?

A: For 2020, the annual contribution limit to an HSA is $3,550 for individuals and $7,100 for a family. People age 55 or older are permitted to kick in an extra $1,000 each.

For dual-income households, dividing the family’s $7,100 contribution limit can be complicated. If both spouses have individual insurance coverage at work, each must set up and fund a separate HSA, up to the $3,550 limit, Mr. Ramthun said.

However, if one spouse has family coverage, that person can contribute up to $7,100, even if the second spouse has separate HSA-eligible health insurance. (The second spouse must refrain from making HSA contributions that take the family above the $7,100 limit.)

Q: What if my spouse and I have an HSA and divorce?

A: HSAs are similar to IRAs in that there can only be one account holder. Depending on the divorce agreement, the assets in each former spouse’s HSA could potentially be divided. “That’s up to the court or whoever is handling the divorce,” Mr. Ramthun said.

Q: Can beneficiaries inherit an HSA tax-free?

A: If you name your spouse as your HSA beneficiary, he or she can inherit the account tax-free. If your beneficiary isn’t your spouse, he or she may have to pay income tax on the account’s value as of the date of death, said Sarah Brenner, director of retirement education at Ed Slott & Co. Within a year of death, the beneficiary should claim tax-free reimbursement from the account for any unreimbursed medical bills the account owner accrued, Ms. Brenner said. That will reduce the balance the beneficiary must pay tax on.

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