For those with a health savings account, December is a great time to review how it has been used and to see if there are ways to better optimize the account.

One: Let it Grow!!!

When it comes to HSAs, often the best advice is Let it Grow, Let it Grow!!! Sing it to the tune of the popular Disney movie song if it helps you to remember.

Spend HSA money only if one of the following two adjectives apply: DIRE or ELDERLY. Those neither in a dire situation nor elderly should think twice before spending HSA money! Instead, Let it Grow!

The tax benefits of an HSA are so powerful that funds should stay in the HSA (to keep growing tax free) and only be removed in dire (medical or financial) circumstances or by the elderly. Unless you leave your HSA to your spouse or a charity, HSAs are not great assets of leave to heirs. Thus, HSAs are great to spend down in your later years (after years of tax-free growth). 

Two: Max Out Payroll Contributions by December 31st

While you can contribute via non-payroll contribution by April 15, 2020 for 2019, contributing to your HSA through payroll deductions is generally optimal since it secures both an income tax deduction and a payroll tax deduction for the money contributed.

If you didn’t max out your HSA through payroll deductions in 2019 and your employer allows HSA payroll deductions, write the check to your HSA in early 2020 (for 2019) and set up your 2020 payroll elections so as to max out your HSA through payroll deductions in 2020.

Three: Review HSA Investment Allocation

Those with low-cost diversified investment choices in their HSA are generally well advised to invest in higher growth assets inside their HSAs. The HSA is a great tax-protected vehicle. That tax protection is best used for high growth assets. 

Those who have invested their HSA funds solely or mostly in cash should consider reassessing their HSA investment strategy.

Four: Track Medical Expenses 

Medical expenses incurred after coverage begins under a high deductible health plan (a “HDHP”) can be reimbursed to you from an HSA many years in the future. There is no time limit on the reimbursement. Unless you are elderly, long-delayed reimbursement (instead of directly paying medical expenses with a HSA) is usually the tax-optimal strategy. Keep a digital record of your medical expenses and receipts to facilitate reimbursements out of the HSA many years in the future. 

Five: Properly Report HSA Income (CA, NJ, NH, TN)

HSAs are tax-protected vehicles for federal income tax purposes and in most states. On your federal tax return, you need to report your HSA contributions and distributions (see Form 8889). However, you are not taxed on the interest, dividends, and capital gains earned in the HSA, and you do not need to report these amounts. 

It is very different if you live in California and New Jersey. Neither California nor New Jersey recognize HSAs as having any sort of state income tax protection. They are simply treated as taxable accounts in those states. In preparing your California or New Jersey state tax return, you must (1) increase your federal wages for any excluded HSA contributions, (2) remove any deduction you took for HSA contributions (non-payroll contributions to your HSA), and (3) report (and pay state income tax on) your HSA interest, dividends, capital gains, and capital losses.

This last step will generally require accessing your HSA account online and pulling all of the income generating activity, including asset sales, in order to properly report it on your California or New Jersey tax return. 

Tennessee and New Hampshire do not impose a conventional income tax, but do tax residents on interest and dividends above certain levels. HSA interest and dividends are included in the interest and dividends subject to those taxes.

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This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.