Deductible medical plans make more sense

Deductible medical plans make more sense

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This is the time of the year when a lot of people are scrambling to get their tax returns prepared by the April 15th filing deadline. One of the perennial obstacles that I encounter when preparing income tax returns for my clients is the ability to take a deduction for medical expenses.

Medical expenses — The ‘take and take’ deduction

Medical expenses are one of the “take and take” deductions for which IRS is notorious. Simply put, you can take a deduction for qualifying medical expenses; however, the IRS will take the deduction away from you to the extent that it exceeds 7.5% of your adjusted gross income, or AGI. It doesn’t get easier in 2013 with the increase in the threshold from 7.5% to 10% except for individuals age 65 or older who may continue to use the 7.5% rule through 2016.

Barring a low AGI or an extraordinary amount of medical expenses, it’s very difficult for the average person to benefit from a medical deduction. Unless, that is, you have a deductible medical plan, otherwise known as a health savings account, or HSA.

What is an HSA?

HSAs have been in existence since 2004. They offer a way to circumvent the medical deduction limit for a healthy portion of otherwise nondeductible medical expenses. The irony is that you don’t need to incur a single dollar of medical expense in order to take a deduction on your tax return.

An HSA is a tax-favored account that’s used together with an HSA-compatible health plan. It allows you to make contributions up to specified limits on a pre-tax or tax-deductible basis to use to pay for eligible medical expenses. Similar to an IRA account, the funds grow tax-deferred.

Contributions to the account and earnings aren’t taxable provided that distributions from the account are used to pay for eligible medical expenses. Unlike additions to cafeteria plans where you must “use it or lose it,” any unused balance in an HSA account carries forward from year to year.

Qualifying for an HSA

There are four requirements you must meet in order to be eligible for an HSA:

1. Must be covered under a high deductible health plan (HDHP)
2. Have no other health coverage with limited exceptions
3. Not enrolled in Medicare.
4. Cannot be claimed as a dependent on someone else’s tax return.

An HDHP has (a) a higher annual deductible than typical health plans and (b) a maximum limit on the total of annual deductible and out-of-pocket medical expenses that you must pay for covered expenses.

Contribution limits

Any eligible individual can contribute to an HSA, including an employee, employer, or self-employed individual. The amount that may be contributed in 2013 is subject to a limit of $3,250 for a single plan and $6,450 for a family plan. Individuals age 55 and over can make an additional, or “catch-up,” contribution of up to $1,000.

The contribution amounts are a pre-tax deduction for employees and an “above-the-line” deduction for self-employed individuals that reduces AGI. As such, there’s no 7.5% or 10% medical deduction threshold to worry about nor is it subject to the 3% of itemized deductions limitation that was reinstated in 2013.

A potential side benefit of HSA contributions is that they may enable you to qualify for larger AGI-sensitive tax deductions as a result of the reduction of AGI. In addition, all states with state income tax follow federal tax treatment except for Alabama, California, and New Jersey which don’t provide any tax benefits for HSAs.

Eligible medical expenses

Medical expenses that are eligible for reimbursement are identical to otherwise deductible medical expenses if you don’t have an HSA plan. They must be primarily to alleviate or prevent a physical or mental defect or illness. Expenses that are merely beneficial to general health, such as vitamins, cannot be claimed.

Eligible medical expenses include, but aren’t limited to, the following:

  • Long-term care insurance premiums subject to age-based limitations
  • Expenses applied to health plan deductibles
  • Dental care
  • Vision care
  • Prescriptions
  • Certain medical equipment
  • Qualified long-term care services

HSA plans make sense now more than ever

With skyrocketing health care premiums and the increase in the medical threshold from 7.5% to 10%, HSA plans fill a niche in a retirement income plan since they offer several benefits that can enhance the longevity of a plan:

  • Lower health insurance premium associated with high deductible plans
  • Ability to convert otherwise non-deductible medical expenses into a tax deduction
  • Tax deduction in 2013 of up to $3,250 or $8,450 depending upon type of plan (single or family) and age of participants
  • Tax-deferred growth of contributions and earnings
  • Tax-free withdrawals for funds used to pay for eligible medical expenses
  • May enable you to qualify for larger AGI-sensitive tax deductions due to reduction of AGI for HSA contributions

Once you file your 2012 income tax returns, if you don’t have one already, start your 2013 income tax planning by investigating an HSA plan. A good resource for additional information is

DISCLOSURE: Robert Klein’s HSA is administered by HSA Bank.

23 Corporate Plaza Drive, Suite 150
Newport Beach, CA 92660-7908

Phone: (949) 251-0910


Advisory services offered through Retirement Income Center, a Registered Investment Advisor

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