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Maximizing Your Health Savings Account (HSA): Strategies for Tax Planning and the Beneficiary Burden

Updated: Oct 5, 2023

Health Savings Accounts (HSAs) are powerful financial tools that offer numerous benefits for those looking to save for healthcare expenses while enjoying tax advantages. However, accumulating too much money in your HSA can raise questions about how to effectively manage and optimize those funds. In this article, we will explore what you should do if you find yourself with excess funds in your HSA, including strategies for tax planning and beneficiary options.

Understanding the basics, before diving into strategies for managing an overfunded HSA, it is important to grasp the fundamentals of these accounts:

  1. Tax Advantages: Listen to me carefully, HSAs offer triple tax benefits! Contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are also tax-free. I can only express this importance so much. If you are eligible for an HSA please fund this meaningful account.

  2. Contribution Limits: In 2023, the annual contribution limits are $3,650 for individuals and $7,300 for families. Individuals aged 55 and older can make an additional $1,000 "catch-up" contribution. Talk about tax planning, this could be a big move to push you down to a lower tax bracket while not affecting your IRMAA Medicare calculations later! For more information “Will I avoid IRMAA Surcharges on Medicare Part B & D

  3. Excess Contributions: If you over-contribute to your HSA, you may face penalties and taxes. It is crucial to monitor your contributions and stay within the annual limits. Read more about Tax Planning.

Side note: most assets in HSAs are not invested in the market but rather are parked in savings accounts. For long-term goals, this may not be in your best interest.

What to do with an overfunded HSA?

  1. Maximize Tax-Advantaged Growth: If your HSA balance is substantial, consider viewing it as a long-term investment vehicle. Invest the excess funds in a diversified portfolio of stocks, bonds, or other options. This can potentially yield higher returns, allowing your HSA to grow tax-free over time. That is where the real impact can be.

  2. Utilize HSA Funds for Non-Medical Expenses: After turning 65, you can withdraw HSA funds for non-medical expenses without penalty (though income tax will apply). This essentially transforms your HSA into a tax-advantaged retirement account. However, keep in mind that using HSA funds for non-medical expenses may reduce your ability to cover future healthcare costs.

    • A workaround can be very easy and advantageous as I will explain next.

  3. Three Tax Planning Strategies: a. Pay Out-of-Pocket for Medical Expenses: Consider covering eligible medical expenses with your own funds while leaving your HSA untouched. Keep detailed records and receipts, allowing your HSA to grow over time.

To use a simple example, let’s say someone paid $5,000 out of her taxable/non-HSA account to cover healthcare expenses incurred in 2022. In 2023, they contributed the maximum family contribution of $7,750 in their HSA, letting the money build up rather than spending from it. If they needed a vehicle in December 2023, they could pull $5,000 from her HSA to use as a downpayment (an amount equal to her outlays for healthcare). That withdrawal would be tax-free provided she could document the 2022 out-of-pocket healthcare costs. Let’s take it further and use $5,000 per year for 10 years and that is a $50,000 tax strategy. Ultimately, letting the HSA grow over your life may be the best option.

b. Contribute to an HSA in a Tax-Favored Manner: If you have a high-deductible health plan (HDHP), continue making maximum contributions to your HSA. These contributions are tax-deductible and can help offset your taxable income. c. Plan for Retirement Healthcare Costs: As healthcare expenses tend to rise in retirement, having an overfunded HSA can be a valuable asset. Allocate your HSA funds towards future medical costs, such as Medicare premiums and long-term care.

Beneficiary Options

HSAs can outlive their original account holders, so it's essential to consider beneficiary options:

  1. Spouse Beneficiary: Naming your spouse as the beneficiary allows them to inherit your HSA without tax implications. They can use the funds for qualified medical expenses without penalties or taxes. Be mindful that you may both be near the same age meaning HSA spend down should be prioritized.

  2. Non-Spouse Beneficiary: If you designate a non-spouse beneficiary, the HSA loses its tax-advantaged status. The beneficiary will owe income tax on the account's fair market value in the year of your passing. To mitigate this, consider leaving your HSA to a non-spouse beneficiary only if you anticipate them using the funds for medical expenses. This is the one big Gotcha since there is no step up in the basis.

  3. Charitable Donations: You can also name a qualified charitable organization as your HSA beneficiary. This can be a tax-efficient way to leave a legacy while supporting a cause you care about.

An overfunded HSA can be a financial blessing, but it requires thoughtful planning to maximize its benefits and avoid potential tax pitfalls. By investing wisely, employing tax planning strategies, and carefully considering your beneficiary options, you can make the most of your HSA and secure your financial future while covering healthcare expenses effectively. Always consult with a financial advisor or tax professional to tailor these strategies to your unique financial situation and goals.

Content provided by

Todd Pouliot, AIF

Please consult with your own tax, legal, and financial advisors for personalized advice.

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