Interesting HSA Distribution Rule

[kramer]

I was researching the HSA distribution rules since I hope to open one soon. My plan of action has been like many others here and that is to build up HSA savings during the early years, let the investments grow tax free, and only spend them later when I am older -- even if I incur health expenses in the short term. One thing that occurred to me is that it is possible to oversave, especially if you start the account while you are young. While this is not a disaster (you can withdraw the money after age 65 and pay taxes on it like you do for a Traditional IRA), it is not optimal.

But it turns out that you can withdraw from an HSA for any allowable health expense since you opened the account, even if it was many years earlier. I am mentioning this to advise HSA account holders to SAVE ALL YOUR ELIGIBLE RECEIPTS FOREVER. You may be 68 years old and fortunate enough not to have used most of your HSA. But if you had saved receipts for expenses from previous years, you could pull out some or all of the money at any time for any reason and incur no tax liability.

According to Slide 31 on required documentation at:
http://www.treas.gov/offices/public-affairs/hsa/pdf/all-about-HSAs_040507.pdf
You need to save receipts and documentation that 1) prove the expense and 2) prove that the expense was not reimbursed by another source or taken as an itemized deduction on your tax return.

Reference: Q&A 39 at:
http://www.treas.gov/press/releases/reports/hsanotice200450072304.pdf

Q-39. When must a distribution from an HSA be taken to pay or reimburse, on a taxfree basis, q ualified medical expenses incurred in the current year?
19

A-39. An account beneficiary may defer to later taxable years distributions from HSAs to pay or reimburse qualified medical expenses incurred in the current year as long as the expenses were incurred after the HSA was established. Similarly, a distribution from an HSA 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 HSA 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 in any prior taxable year. See Notice 2004-2, Q&A 31 and also Notice 2004-25, for transition relief in calendar year 2004 for reimbursement of medical expenses incurred before opening an HSA.

Kramer

 

[mykidslovedogs]

Hi Kramer,

I have mentioned this before, but not in nearly as great of detail as you have! Thanks for bringing it up again. It is a very important feature of the HSA and one reason why you should put money into an HSA before EVER putting money into an IRA. In fact, if you can't afford to fund both, I would fund an HSA first. Are you sure you don't want to become an Agent?

 

[kramer]

Thanks for the confirmation, MKLD.

This reinforces my plan to scan in all of my medical and health records. And to continue to do that each year. I don't plan to throw the paper out, but I want electronic backup copies. One fire or theft could destroy paper records. I would rather have redundancy.

Kramer

 

[TromboneAl]

Thanks for the reminder. I'm going to have a special file folder just for medical expenses to be reibursed someday.

I've realized that I'd better do a good job of keeping all receipts, since I may not need them for, say, 15 years or longer. I might scan them in so that I can have backups.

Can someone confirm for me that qualified expenses also include:

Vision Exams
Dental work
Eyeglasses
Contacts

 

[TromboneAl]

Here's another interesting rule that seems too good to be true:

Tax-free distributions can be taken for
qualified medical expenses of:
– person covered by the high deductible
– spouse of the individual (even if not covered
by the HDHP)
– any dependent of the individual (even if not
covered by the HDHP)

So even if wife and daughter are covered by normal health insurance plans, I can deduct all their expenses.

 

[gandalf42]

Here's another interesting rule that seems too good to be true:

Tax-free distributions can be taken for qualified medical expenses of:
– spouse of the individual (even if not covered by the HDHP)
– any dependent of the individual (even if not covered by the HDHP)

I hadn't heard of those points. That's a big deal for our family!
Thanks!!

 

[mykidslovedogs]

Here is a good guide to use for eligible expenses. Even some over the counter drugs can be paid for out of your hsa account so long as they are being used to treat a specific condition:

http://www.hsabank.com/hsainfo/medical_expenses.aspx

 

[Rich_by_the_Bay]

HSA is a good option for those who have access to it and can afford to fund it and cover the high deductible. I plan on setting one up shortly before retirement. My current employer-sponsored PPO plan with prescription coverage is too good to pass up now, but when I have to start paying the premiums, the HSA/high deductible plan looks good, as long as my DW and I remain healthy.

 

[bow-tie]

HSA is a good option for those who have access to it and can afford to fund it and cover the high deductible. I plan on setting one up shortly before retirement. My current employer-sponsored PPO plan with prescription coverage is too good to pass up now, but when I have to start paying the premiums, the HSA/high deductible plan looks good, as long as my DW and I remain healthy.

Rich, wouldn't waiting to utitlize an HSA greatly limit how much you can save for med. expenses? I think HSA accts have a cap you save each year.. something like 3k/yr or something like that.

 

[FIRE'd@51]

You need to save receipts and documentation that 1) prove the expense and 2) prove that the expense was not reimbursed by another source or taken as an itemized deduction on your tax return.

I believe it has been argued on other HSA threads in this forum, that in many instances, you may be better off to take the itemized deduction, and let the money compound in your HSA.

 

[Rich_by_the_Bay]

Rich, wouldn't waiting to utitlize an HSA greatly limit how much you can save for med. expenses? I think HSA accts have a cap you save each year.. something like 3k/yr or something like that.

My current indemnity policy (robust coverage, fully paid by my employer) is very generous, includes prescription coverage and allows me to maintain a medical reimbursement account as well, so might as well hang on to it as long as I can. The HSA-related option eliminates the medical reimbursement acct, has no prescription coverage (other than using your HSA funds), and a higher deductible.

Yes, I'll lose a bit of a headstart on funding my HSA balance, but the benefits are well worth it as long as my employer is footing the bill. Come FIRE, I lose the med. reimbursement acct in either case, and the difference in premium which I will be paying myself changes the whole equation.

This stuff is waaayyy too complicated.

 

[kramer]

I believe it has been argued on other HSA threads in this forum, that in many instances, you may be better off to take the itemized deduction, and let the money compound in your HSA.

This is an interesting suggestion. Basically, if you are sure that you will have plenty of expenses to "use up" your HSA in the future (true for vast majority of people) then it may make sense to itemize major health expenses in years where that deduction amounts to significant savings, and not use your HSA funds in that case.

I think if you also have Schedule C income and are deducting the actual health insurance premiums, then we have just about everything covered tax-wise

Kramer

 

[eridanus]

Here is a good guide to use for eligible expenses. Even some over the counter drugs can be paid for out of your hsa account so long as they are being used to treat a specific condition:

http://www.hsabank.com/hsainfo/medical_expenses.aspx

Be careful. HSA Bank claims that stop-smoking program OTC drugs can be expensed, but the IRS publication states that these drugs require a prescription.

"However, you cannot include medical expenses amounts you pay for drugs that do not require a prescription, such as nicotine gum or patches, that are designed to help stop smoking."

http://www.irs.gov/pub/irs-pdf/p502.pdf (p. 13)


I had forgotten that travel expenses are allowed at the medical mileage rate.

 

[mykidslovedogs]

Be careful. HSA Bank claims that stop-smoking program OTC drugs can be expensed, but the IRS publication states that these drugs require a prescription.

"However, you cannot include medical expenses amounts you pay for drugs that do not require a prescription, such as nicotine gum or patches, that are designed to help stop smoking."

http://www.irs.gov/pub/irs-pdf/p502.pdf (p. 13)


I had forgotten that travel expenses are allowed at the medical mileage rate.

The information you have on the ability to use HSA$$ for over-the-counter drugs is outdated. According to Rev Rule 2003-102, there are certain over the counter drugs that you can use HSA$$ for:

http://www.efsbenefits.com/Vendor - Group Forms/IRS - Initial Guidance on HSAs.pdf

Scroll down to where I have marked the paragraph that explains this.

HSA Bank's information is correct.

 

[eridanus]

The information you have on the ability to use HSA$$ for over-the-counter drugs is outdated. According to Rev Rule 2003-102, there are certain over the counter drugs that you can use HSA$$ for:

http://www.efsbenefits.com/Vendor - Group Forms/IRS - Initial Guidance on HSAs.pdf

Scroll down to where I have marked the paragraph that explains this.

HSA Bank's information is correct.

It's a 2006 publication. I think that's more current than a 2003 EBIA memo.

http://www.irs.gov/pub/irs-pdf/p502.pdf

 

[mykidslovedogs]

It's a 2006 publication. I think that's more current than a 2003 EBIA memo.

http://www.irs.gov/pub/irs-pdf/p502.pdf

The IRS has never rescinded the revision. You just have to look it up in the rev rule - not the actual publication 502. The rule that certain over the counter drugs can be paid for out of an HSA has been in place since rev rul. 2003 was published. Trust me on this one. I've been selling HSAs since they first came out.

Here is a link that you may put your trust in:

http://www.irs.gov/irb/2003-38_IRB/ar08.html

Scroll down to the 8th paragraph below "Laws and Anyalysis". These same rules all apply to HSAs.

 

[REWahoo]

According to this April 5, 2007 US Treasury overview information on HSAs...

http://www.treas.gov/offices/public-affairs/hsa/pdf/all-about-HSAs_040507.pdf

...over the counter drugs do qualify (page 26):

HSA Distributions:

• Distribution is tax-free if taken for “qualified
medical expenses”.
– Now includes over-the-counter drugs

 

[eridanus]

Ok, thanks mkld and REW. I did find that a "qualified medical expense" is ambiguous. This is another case where the IRS will decide when they haul your butt into the audit interview.


http://www.treas.gov/offices/public-affairs/hsa/faq_using.shtml#hsa2
------------------
How do I know what is included as “qualified medical expenses”?

Unfortunately, we cannot provide a definitive list of “qualified medical expenses”. A partial list is provided in IRS Pub 502 (available at www.irs.gov). There have been thousands of cases involving the many nuances of what constitutes "medical care" for purposes of section 213(d) of the Internal Revenue Code. A determination of whether an expense is for "medical care" is based on all the relevant facts and circumstances. To be an expense for medical care, the expense has to be primarily for the prevention or alleviation of a physical or mental defect or illness. The determination often hangs on the word "primarily."

Who decides whether the money I’m spending from my HSA is for a “qualified medical expense?”

You are responsible for that decision, and therefore should familiarize yourself with what qualified medical expenses are (as partially defined in IRS Publication 502) and also keep your receipts in case you need to defend your expenditures or decisions during an audit.

 

[kramer]

eridanus,

The tax code is littered with principles like this laid out and left open to interpretation. For instance, a more ambiguous area is tax residence. I think the principles laid out for medical expenses are pretty clear. You will only run into problems if you are audited and you can't support your position. The tax authorities are not looking to trip you up in this area -- they are just trying to prevent abuse.

Kramer

 

[spideyrdpd]

Drugstore.com has an fsa section. They say any item that is ok for the hsa as well

 

[justin]

Time to revive an old thread. Here's a hypothetical that has been bugging me: Let's say I open HSA 1 through my employer at Aetna. A year later, I open up HSA 2 at my local bank. I'm making contributions to each account which add up to the total allowable amount each year. I max out the contributions for 10 years. Then I roll all HSA's over into HSA 3 at a different custodian. Over all these years I've been saving receipts for med expenses. After HSA 1 and 2 are closed, can I withdraw from HSA 3 to reimburse myself tax-free for all amounts incurred since HSA 1 was opened? Or am I limited to reimbursing amounts (tax-free) for expenses incurred only since HSA 3 was opened?

I like the idea of keeping receipts for 30 years, then withdrawing tax-free for all med expenses incurred over that time period, but I'm worried that changing custodians and rolling over HSA's over time may extinguish the right to reimbursement for accounts that are rolled over and closed.

Another issue is what happens if the account owner dies? If I've got $100000 in my HSA account in 30 years with a suitcase full of receipts totaling $100000, could my estate withdraw the full $100,000 tax-free and have it pass to heirs as cash (after tax money to the heirs)?

 

[kramer]

Justin,

I like the idea of keeping receipts for 30 years, then withdrawing tax-free for all med expenses incurred over that time period, but I'm worried that changing custodians and rolling over HSA's over time may extinguish the right to reimbursement for accounts that are rolled over and closed.

Yes, you can withdraw funds later no matter how many HSA custodians you have had. Remember, your HSA custodian is not really a "gatekeeper" demanding receipts to justifiy withdrawals. They just give you your money when you ask for it (you request it by writing a check, using a debit card, etc.). To them, it is really like a checking account except that they have some simple annual reporting requirements on deposits and withdrawals to the IRS on the account.

Whether you pay taxes on the withdrawals is between you and the IRS and nothing to do with your custodian. You would make this decision when you filed taxes for that year. The only time you would need to show receipts is if you got audited. It really is quite simple.

Be sure to backup all of your long term receipts electronically by scanning them in in case of fire or loss.

I will be opening my HSA next month. So if I learn anything else I will be sure to share it.

Kramer

 

[justin]

Yes, you can withdraw funds later no matter how many HSA custodians you have had. Remember, your HSA custodian is not really a "gatekeeper" demanding receipts to justifiy withdrawals. They just give you your money when you ask for it (you request it by writing a check, using a debit card, etc.). To them, it is really like a checking account except that they have some simple annual reporting requirements on deposits and withdrawals to the IRS on the account.

Whether you pay taxes on the withdrawals is between you and the IRS and nothing to do with your custodian. You would make this decision when you filed taxes for that year. The only time you would need to show receipts is if you got audited. It really is quite simple.

The part that concerns me is that the IRS regs state that, basically, you have to have the "account" opened at the time the expense was incurred. The issue is whether a reimbursement is tax-free for an expense incurred BEFORE your current HSA account was opened, but the expense was incurred AFTER a previous HSA was opened, when the funds from the earlier HSA were transferred to the HSA opened later.

Let's say I contribute to my credit union HSA in 2007 and 2008 and incur expenses in 2007 and 2008. In 2009, I roll over the credit union HSA to hsadministrators.com. I know I can reimburse myself tax-free for expenses incurred in 2009 from my hsaadministrators HSA account. But can I reimburse myself tax-free for expenses incurred in 2007 and 2008 (time periods prior to the opening of my current account)?

 

[TromboneAl]

prove that the expense was not reimbursed by another source or taken as an itemized deduction on your tax return.

How do you prove that it wasn't reimbursed from another source? For example, if I spend $70 for eyeglasses, how do I prove that wasn't paid for by insurance?

BTW, I got a free app to simplify scanning at www.DocsVault.com. Seems to work pretty well so far.

There certainly is a risk that in the course of 10 or 20 years you'll lose those receipts (fire, etc.). By scanning and backing up (with offsite backups), I'll at least reduce that chance.

 

[Martha]

My favorite HSA "cheat sheet" is from the treasury department here: http://www.ustreas.gov/offices/public-affairs/hsa/pdf/all-about-HSAs_040507.pdf

This says if the recipient on death of the account holder is not the holder's spouse, then the account is no longer treated as an HSA. The funds in the account are subject to income tax except for qualified medical expenses of the deceased paid by the recipient. This language is still a bit vague--can the recipient reimburse for expenses previously paid by the decedent? It doesn't quite sound that way, but heck, this is just a brochure, not the law.

So the short answer is I don't know.