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Fund Your HSA with Your IRA

December 11th, 2007 at 01:00 am

As discussed in the Financial Abundance Guide, if your marginal federal income tax rate is 25 percent or higher, on an after tax basis, you will save money with a High Deductible Health Plan (HDHP), when you fully fund your Health Savings Account (HSA). In 2007, if you are single and your Adjusted Gross Income (AGI) is over $31,850 or filing jointly with an AGI over $63,700, an HDHP/HSA combination will save you money, as long as you fully fund your HSA.

For many people, the ability to fully fund their HSA may be a challenge. “Fully funding” requires that a single person deposit $2,850 or that a family deposit $5,650 into an HSA. To help solve this problem, the Tax Relief and Health Care Act of 2006 allows you to do a one-time funding of your HSA by rolling over IRA funds into your HSA.

This rollover is similar to doing an IRA to Roth IRA conversion. However, with an HSA rollover, you are not required to pay taxes on the funds transferred to your HSA (as long as you maintain your HDHP for at least 12 months). Like a Roth IRA, all HSA funds grow on a tax free basis and can be withdrawn tax-free, as long as the funds are used to pay for health care related expenses.

Another one time funding source for your HSA is a rollover from an employer-sponsored flexible spending account (FSA) or health reimbursement account (HRA). Your rollover is limited to the account balance on the date of transfer or on September 21, 2006, whichever is less. The rollover must also be made before January 1, 2012. If your yearly FSA contributions will not be consumed, this approach may keep you from losing the remaining FSA funds.

If you have a High Deducible Health Plan (HDHP), fully fund your Health Savings Account (HSA). By doing this, your total after-tax health care costs are virtually guaranteed to be lower than they would be with a comparable “low deductible” health care plan.

Choose the High Deductible Health Plan

November 8th, 2007 at 11:34 pm

Many companies are now offering the choice of a “traditional” health care plan or a high deductible health plan (HDHP). Often, the employees are only told that the HDHP costs less (usually by 20% - 30%) and has a higher deductible. The deductible for a family “traditional” plan is often at least $500 per individual and $1,000 for the family. For a HDHP the family deductible is often as much as $3,000.

If your traditional plan costs $200 per month and the HDHP costs $160 per month (20% less) you might be believe that the $40 per month ($480 per year) savings is not worth the risk of possibly paying $2,000 more in deductible expenses. This would be true, if you do not take advantage of the tax free Health Savings Account (HSA) that can be matched with the HDHP.

However, if you are in at least the 25% federal income tax bracket and deposit the family policy maximum of $5,650 into your HSA, the cost of an HDHP will always be less than a the cost of using a traditional plan.

If you are in the 25% federal tax bracket, the $5,650 HSA deposit will provide a federal income tax savings of ($5,650 *25%) = $1,412.50.

Next, using your HSA for medical expenses lets you pay for them with tax-free dollars. The $3,000 deductible can be paid with these tax-free funds. This reduces the $3,000 cost by your 25% tax bracket to a cost of $2,250 on an after tax basis.

Let’s add up the after tax costs of each plan. The traditional plan costs $480 more and saves you ($2,250 - $1,000) = $1,250 on after tax deductible costs, for a net “savings” of ($1,250 - $480) = $700

However, the HSA deposit of $5,650 has an income tax saving of $1,412.50. When the income tax savings is included, the HDHP plan costs ($1,412.50 - $770) = $642.50 less than the “traditional plan, even when your health care costs “max” out the $3,000 deductible.

If you only use $1,000 in medical expenses for the year, the savings with the HDHP is $2,142.50. This represents the sum of the insurance savings ($480), the HSA tax savings ($1412.50) and the savings from paying the deductible with funds that are never taxed ($250).

If you are in a higher tax bracket and/or if you pay state income taxes, your savings with an HDHP are even greater. Plus, the funds remaining in the HSA continue to grow tax free and can be used for future medical expenses tax free.

The bottom line is that, if you are in at least the 25% federal income tax bracket and your company offers an HDHP, you will come out ahead with the HDHP, as long as you contribute the maximum amount allowed to your HSA.