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Tax-Free Benefits of HSAs and Cafeteria Plans

You’ve probably heard information about the “new Health Savings Accounts (HSAs),” but may be unsure of what they are and/or the requirements. Basically, they are a way to set aside tax-free funds for medical purposes for eligible individuals. The tax favorable elements are:

  • Contributions you make to an HSA are deductible, with limits.
  • Contributions your employer makes aren’t taxed to you.
  • Earnings on the funds within the HSA are not taxed.
  • Distributions from the HSA to cover qualified medical expenses are not taxed.

To be eligible for an HSA, you must be covered by a “high deductible health plan.” For 2017, this is a plan with an annual minimum deductible of at least $1,300 for single coverage, or $2,600 for family coverage. There are also limits, other than premium coverage, on annual out-of-pocket expenses, all of which are indexed annually for inflation. You cannot be covered by another plan, which is not a high deductible plan, or one that provides any benefit covered by your high deductible plan. However, you may have separate coverage for accidents, disability, dental, vision or long-term care.

An HSA may be established by, or on behalf of, any eligible individual. For example, if you are an eligible individual, the amounts contributed to your HSA by your employer for medical expenses are excludable from your gross income. Further, these employer contributions are not subject to withholding FICA or FUTA taxes. The 2017 contribution amounts are $3,400 for single, or $6,750 for family, and if age 55 or older, an additional $1,000 catch-up contribution is allowed.

The HSA account is generally exempt from taxation, and there is no tax on earnings. However, taxes may apply if contribution limits are exceeded or distributions are not used for qualified medical expenses. After age 65, distributions may be taken from the HSA for non-qualified expenses. However, income tax will be imposed, but not penalties. The HSA may also be rolled over to a beneficiary upon death, much like an IRA. Thus, you could treat the HSA account as an additional IRA for the amounts not used to reimburse medical expenses.

In a 2004 article, Governor Bush stated, “HSAs provide new opportunities for Floridians to more closely manage their health care costs.” HSAs provide a more cost-effective way for employers to offer high-deductible health plans to employees, while employees will have more incentive to save money for medical expenses. At all times, the money in an HSA belongs to the employee, meaning it’s portable.

On the other hand, if a high deductible plan is not an option for you, your employer may offer a Section 125 Cafeteria Plan for insurance premiums and medical expense reimbursements. A cafeteria plan can be funded with employer contributions, employee contributions or a combination of both. You could have a lower taxable income where contributions to the cafeteria plan are from pre-tax income. For example, if you are required to contribute a portion of your health insurance premiums (i.e. family/spouse coverage) to your employer, it could be deducted from your gross income before taxes. Also, if the plan allows medical reimbursements, these, too, could be deducted from your gross income before taxes. This not only saves you withholding and FICA taxes, but also enables you to deduct medical expenses that might not otherwise be deductible in your itemized deductions on your tax return.

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