Health Savings Accounts are EVEN BETTER than we thought!
Health Savings Accounts (H.S.A.) are one of the best investment vehicles in the world……they are a tax-advantaged triple threat! First, they allow you to pay Qualified Medical Expenses with pre-tax dollars. Second, they provide an immediate deduction from an income tax standpoint. Third, if left alone to grow for years and years and years and years (as your friends at Dashboard Wealth Advisors espouse), ALL of this growth is also TAX-FREE. Nothing else on the face of the planet does all this – NOTHING.
However, as exciting as this is, it’s been something we’ve written about for years, and this isn’t the cause for my newly found EUPHORIA. “Well then, Scott, what is the cause for this newly found H.S.A. Euphoria?”, you might say. Glad you asked!!
I was recently talking to a long-time High School buddy, and great friend and client, who like me is a “recovering auditor and certified geek 😊”. He asked me how I am tracking my Health Care Spending. Without missing a beat, I went into my tirade about the nuances of H.S.A.’s and why it is criminal to spend any of the funds in these vehicles until well into retirement years, blah blah blah. After giving me a minute to calm down, he then specified he was not inferring that he was depleting his H.S.A. account, he was merely tracking each and every medical bill that he paid (with his after-tax dollars) so he could then use these expenses to reimburse himself with H.S.A. dollars much later in his retirement years. I was aghast, and I honestly didn’t think this was allowed.
After making a slew of phone calls and doing some digging, we ran across IRS Notice 2004-50 (Revised and corrected – 8/9/04) which sheds some serious light on the timing of reimbursements. Here is an excerpt from this IRS publication:
From IRS Notice 2004-50
Q-39: When must a distribution from an H.S.A. be taken to pay or reimburse, on a tax-free basis, qualified medical expenses incurred in the current year?
A-39: An account beneficiary may defer to later taxable years distributions from H.S.A.’s to pay or reimburse qualified medical expenses incurred in the current year as long as the expenses were incurred after the H.S.A. was established. Similarly, a distribution from an H.S.A. in the current year can be used to pay or reimburse expenses incurred in any prior year as long as the expenses were incurred after the H.S.A. was established. Thus, there is no time limit on when the distribution must occur. However, to be excludable from the account beneficiary’s gross income, he or she must keep records sufficient to later show that the distributions were exclusively to pay or reimburse qualified medical expenses, that the qualified medical expenses have not been previously paid or reimbursed from another source and that the medical expenses have not been taken as an itemized deduction (on Schedule A) in any prior taxable year.
THIS IS WHERE THE EUPHORIA SET IN!! From the day one makes his/her first deposit into an H.S.A., every single non-reimbursed medical expense (that has not been claimed as a Schedule A itemized deduction) can be claimed from the H.S.A. at any time thereafter. This means that no matter how large one’s H.S.A. grows to, as long as one’s record-keeping is impeccable, all of this TAX-FREE money can most likely be used.
We’ve been recommending to our clients for many years to add to and not spend H.S.A. dollars until retirement under the auspices that there would be enough medical costs in retirement to absorb the entire H.S.A. balance. Although this might well be true, now we have the luxury of using any and all unreimbursed medical costs from the onset of establishing the H.S.A.
Keep in mind though, using these legacy costs will require some serious record-keeping on your part. After going through this process myself, I feel compelled to share our best practices in getting your H.S.A. record-keeping in order...
Review your old tax returns to determine the year in which you first contributed to a H.S.A. (Line 25 on first page of form 1040). KEEP ALL TAX RETURNS FROM THIS YEAR GOING FORWARD!
Review each year’s tax return from the first year of H.S.A. contribution going forward to determine if you deducted any unreimbursed medical expenses (Schedule A – line 4). If you deducted medical expenses in any given year, you MUST NOT include that year’s medical expenses in your H.S.A. record-keeping.
Know what is considered a “Qualified Medical Expense”. It’s a lot more than just doctor and dentist visits. Some commonly overlooked valid costs include: acupuncture, breast pump and supplies, chiropractor, doctor visits, eye care (including glasses and contacts), dental treatment, hearing aids, hospital services, lab fees, learning disability costs, long-term care, medicines, oxygen, psychiatric care, special education, stop-smoking programs, surgery, vision correction surgery, weight-loss programs, wheelchair and ambulatory care, and many others. For a complete list of qualified expenses, visit the IRS website.
Make a list of ALL primary care doctors/dentists/eye doctors/hospitals/etc. that you and your dependent children have seen since the inception of your H.S.A. Request from them a summary of ALL medical costs incurred as well as a complete itemized bill showing all payments (insurance and self-payments). This is required by the IRS for H.S.A. distributions, and needs to be provided by the billing departments of these places. Personally, I have just completed this process and although it’s a bit painstaking, it’s actually not too bad.
Create a template to track and record ALL unreimbursed medical expenses identified in Step 4 above, but making sure to exclude those years identified in Step 2 above. By the way, Dashboard has created a basic template and will provide it to anyone upon request! CLICK HERE to request your copy now.
We strongly recommend keeping electronic copies of all medical expenses. Remember, you will most likely be submitting these costs for reimbursement 15-25 years into the future. Your current doctors might very well be retired or their practices merged 4 times over. In doing so, here’s what we’d suggest – make a PDF of each itemized bill and save with this naming convention: DATE OF SERVICE, then SERVICE PROVIDER (example 4-22-19 XYZ Dental Associates). That way, when compiling the spreadsheet, it’s easy to then access any and all supporting docs. Whether it’s with Client Vault, Box.com, or some data storage solution of your own, store and secure both your H.S.A. Record-Keeping Log as well as all supporting medical bills and all tax returns for years and years and years.
When the time is right (in retirement), simply look to your H.S.A. Record-Keeping Log and then request a TAX-FREE distribution for ALL of your previous qualified medical expenses.
With this money, enjoy life, give generously and laugh often!