Using a Health Savings Account to Pay for Long-Term Care

Most of us have heard of a Health Savings Account (HSA), but many don't understand the important details about these accounts.

HSAs were intended to provide a way for Americans to save money for out-of-pocket healthcare expenses before meeting a high-deductible health plan (HDHP) deductible. In fact, an individual or family must have an HDHP to open an HSA.

HSAs were primarily intended to soften the financial burden of healthcare expenses for HDHP account holders of all age groups. However, an HSA can be particularly advantageous in paying for long-term care expenses at age 65 or over.

What is a High Deductible Health Plan?

HDHPs have higher deductibles than typical health plans. Created as a means to contain runaway healthcare costs, consumers pay more out of pocket for their healthcare with these policies under the assumption that they will be motivated to spend less. In 2021, plans that qualify as HDHPs under HSA rules must have a minimum annual deductible of $1,400 for singles and $2,700 for families.

Many consumers prefer HDHPs because they have cheaper monthly premiums. As a result, the popularity of such policies increased significantly, especially after the Affordable Care Act (Obamacare) became law. Yet, the downside remains that consumers end up paying more out-of-pocket. To reduce this impact, HSAs were introduced as an attractive way to accumulate money for these expenses.

How Do HSAs Work?

Health Savings Accounts possess remarkable tax advantages:

• Money can be contributed on a pretax basis*
• Funds in an account grow tax-free without limit
• Withdrawals can pay for qualified healthcare expenses without paying taxes

*For 2021, HSA contribution limits allow singles to contribute up to $3,600 annually, and families can contribute up to $7,200. Those over 55 can contribute $4,600 and $8,200, respectively. This means the dollars contributed to an HSA are not subject to federal taxes or most state taxes (except in California and New Jersey.)

HSA withdrawals (also called distributions) can be used to cover qualified medical expenses. Generally, these are the same expenses that can be deducted on an income tax return and are defined in IRS publication 502, Medical and Dental Expenses. However, healthcare expenses paid for with HSA funds cannot be used as itemized deductions on a tax return or reimbursed via a Flexible Spending Account.

Other details about HSAs:

• HSAs can be opened by individuals or families and through some employee benefit plans.
• An HSA opened through an employee benefit plan is portable. When workers move to another employer or exit the workforce, their HSAs follow them.
• HSA account holders cannot be enrolled in Medicare. Also, except for certain exceptions, they cannot be covered by other health plans.
• HSAs are not available to those claimed as dependents on someone else's federal tax return.
• If an HSA withdrawal is used for purposes other than qualified medical expenses before age 65, regular income tax is paid on the funds, plus a 20% penalty. At age 65 or older, only ordinary income tax is payable.
• All HSA withdrawals made during a year must be reported on IRS Form 8889 and filed with that year's Form 1040, 1040-SR, or 1040-NR.

Aside from typical healthcare costs, an HSA can also be used to pay for qualified long-term care expenses and to pay for long-term care insurance premiums.

Qualified long-term care expenses arise from services needed by a "chronically ill" person that have been prescribed by a healthcare professional who has determined the person has either of the following needs in the prior 12 months:

1. The person cannot perform without help at least two ADLs (activities for daily living) like dressing, bathing, or toileting for at least 90 days

or

2. Needs supervision and protection due to cognitive disability (e.g., dementia.)

These needs could be handled by in-home care, assisted living, memory care, or skilled nursing settings. Also, the IRS defines "nursing services" in a separate category of HSA-eligible expenses. Nursing services are defined as those typically done by a qualified nurse or attendant. If the nurse also provides help with housework or shopping, these costs are not covered. Only the nurse's fees for time delivering qualifying healthcare can be paid tax-free from the HSA, including family members who provide the same services as a nurse or attendant.

HSA funds can also pay long-term care insurance (LTCI) premiums with some requirements. When considering buying an LTCI policy, make sure it meets HSA rules.

The amount that an HSA account can be used to pay for LTCI premiums depends on age, with the assumption that older policyholders pay higher premiums:

If spouses each have an HSA, each can withdraw the annual premium limit to pay for their respective LTCI policies.

Want to learn more about long-term care payment options? Check out our complimentary eBook, Planning and Paying for Long-Term Care: What Are My Options?