Risk - Trap - Pitfall - Finance - Chasing Money off a Cliff

11 HSA Pitfalls to Avoid – Part 1

Intro

Health Savings Accounts (HSA) are very powerful in that they can save you a lot on your taxes, but there are many pitfalls/risks that HSA participants should be mindful of. This is Part 1 of 2 episodes detailing 11 HSA pitfalls to avoid. In this episode, we discuss 6 of the 11 pitfalls, including:

  1. Not shoeboxing expenses
  2. Missing qualified expenses
  3. Disqualified expenses
  4. Personal vs. payroll contributions
  5. Over-contributing
  6. Under-contributing

We mentioned that the law may have changed regarding over-the-counter (OTC) medications. It does appear that, per the CARES Act, certain OTC medications may qualify as qualified medical expenses without a prescription, but you should confirm this with your tax advisor. Stay tuned for Part 2.

Podcast

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Hey everybody, welcome to the Bigger Insights Finance podcast, where we’ll help you live

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a life that you don’t need a vacation from.

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This episode is part one of “11 HSA Pitfalls to Avoid”.

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This was originally supposed to be one episode, and when I was drafting my notes for this,

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it started out as “5 HSA Pitfalls to Avoid”, and then it became seven and nine and eleven.

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So I ended up deciding to cut this into two parts.

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So make sure you stay tuned for Part 2.

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Now we like HSAs.

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They’re great Tax-favored Accounts (TFA), and they can really help you save on your taxes.

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But to be honest, there are a lot of pitfalls that you need to be aware of, and it’s very

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easy to make costly mistakes.

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We like talking about HSAs because, you know, no one else really does.

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And because of that, very few people understand A: How powerful they can be, and B: How dangerous

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they can be if you don’t know what you’re doing.

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In this episode, we’re going to be going over several pitfalls that either I or our clients

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have fallen into so that you can learn from our experiences and avoid these issues.

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Now just as a quick caveat, we are not CPAs, tax attorneys, enrolled agents, or other tax

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professionals, and this is not tax advice, so make sure you run any of this by your tax

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advisor.

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All right, so now let’s get into it, but just keep in mind that these are not in any particular

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order.

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The first pitfall is more of an opportunity cost, but it is not shoeboxing your expenses.

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Now we’ll probably get into this in more detail in a future episode, but the HSA shoebox

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rule is essentially that you can reimburse yourself for out-of-pocket qualified medical

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expenses at any point in the future from your HSA funds.

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Now if you play your cards right, this can be very powerful.

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First of all, if you’re investing your HSA, which you might want to consider doing, your

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investment income is tax free in your HSA.

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So let’s say you have a $500 medical bill. If you pay for that out of pocket and leave

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that $500 in your HSA that you would have otherwise used to pay that $500 bill, it remains

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in your HSA and grows tax-free.

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Another thing to consider is that even if you intend to pay that bill immediately, you

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can still consider paying for it out-of-pocket, like on a credit card, for example, and get

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cash back or other rewards, and then immediately reimburse yourself from your HSA.

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Although if you’re going to do that, you might want to also consider the privacy implications

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of that.

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You know, for example, if you got a bill from an HIV clinic or something like that and you

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swipe your American Express card to pay for it. You know, you might want to ask yourself,

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“Do I want American Express to know that I’m paying bills at an HIV clinic?”

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Which by the way, you know, where we’re coming from on that is we also provide privacy and

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security services and we do a Privacy & Security podcast, so go check that out.

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The second pitfall is missing qualified expenses.

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Some of them might actually surprise you like orthodontics.

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This time we checked orthodontics are a qualified medical expense that you can use your HSA

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funds on.

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So you should go review a list of those expenses because some of them might surprise you and

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you might be able to take advantage of them.

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There are also opportunities to pay qualified medical expenses for dependents. Although

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that’s definitely something you’re going to want to run by your tax advisor because the

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rules on that can get a little bit complicated. Especially if you’re shoeboxing and you

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know that person is dependent on your return one year or not another that can get pretty

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complicated, but there are opportunities there as well.

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And if you’ve had an HSA for some time, you might want to think about, did you actually pay

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for a qualified medical expense in the past out-of-pocket, either due to insufficient

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funds or you just didn’t know that it was a qualified medical expense, and can you reimburse

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yourself from your HSA?

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So when I learned about some expenses that I didn’t know qualified and I learned about

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the shoebox rule, I actually went through old receipts, explanation of benefits (EOB) forms

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and bank statements to dig up a bunch of medical expenses that I had in the past that I didn’t

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run through my HSA.

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Now at the time when I paid those expenses, I felt bad about it because I thought it was

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a missed opportunity, but now I have this chunk of shoeboxed expenses that I can reimburse

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myself for at any time that are sitting in my HSA invested in stocks, bonds, commodities

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and CDs that are earning gains and dividends and interest tax-free.

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The third pitfall is distributing money from your HSA for disqualified expenses.

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Now I think that this might have actually changed.

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So this is something that you’re going to want to check on.

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But one of the things that used to really trip a lot of people up was paying for over

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the counter (OTC) medications without a prescription.

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You used to have to have a prescription, like if you wanted to buy ibuprofen or something

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like that, in order for that to be a qualified medical expense.

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And that confused a lot of people because, like if my doctor wrote me a prescription

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for ibuprofen, which they might do sometimes, then you’d get that at the pharmacy and you

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could pay for that with your HSA, that would be fine.

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But if you were to go to the shelf and buy the same thing off the shelf, then it used

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to at least used to be the case that you could not buy that with your HSA.

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But the point of this is not about the OTC medications.

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The point is that you need to be absolutely clear that an expense that you have actually

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qualifies before you use your HSA to pay for it.

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Now, sometimes that’s pretty obvious.

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Like again, if your doctor writes you a prescription, or like if you break your arm or something

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like that, you know, those kinds of expenses are going to qualify.

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But there are other cases like, you know, what we were saying earlier, the orthodontics

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are qualified, you know, that surprises a lot of people.

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And there might be some gray areas as well.

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Like what about certain types of cosmetic surgery?

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So the point is, is to make sure that you know that something qualifies before you use

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your HSA to pay for it.

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And this is another good reason to shoebox your expenses.

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You don’t want to pay for something with your HSA and then find out later that it didn’t

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actually qualify, you’d be better off paying for out-of-pocket and finding out later that

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it does qualify and then reimburse yourself. Because let’s face it, like, you know, if

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you’re at the pharmacy or something and you’re trying to decide whether something qualifies,

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you don’t want to be trying to figure that out. You’d be better off just paying for that

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out-of-pocket and reimbursing yourself later after you find out that it does in fact qualify.

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All right, the fourth pitfall hits me right in the feels because I made this mistake

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several years ago.

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So if you’re one of those people that take pleasure in other people’s pain, turn up your

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volume. And this pitfall is making personal contributions to your HSA versus payroll contributions.

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Now you might think that those should be the same.

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Like if I contribute $1,000 to my HSA through my paycheck versus just through my bank account,

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what’s the difference?

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It’s the same account.

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It’s the same $1,000.

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Why would the tax treatment be any different?

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And the reason why this is different is because it’s the government and this is just how they

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roll.

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But if you’re paying attention, when you make a contribution to your HSA through payroll,

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you’ll notice that that contribution amount gets deducted from your gross pay before social

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security, Medicare, and city taxes are calculated.

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And that’s great.

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That’s what we want.

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Who wants to pay taxes?

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Now what happens when you make a personal contribution?

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So you send $1,000 to your HSA from your checking account. You know, that’s cool, right?

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So you’ll sit down during tax time.

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You’ll go to Schedule 1 and you’ll add an adjustment to your income for that $1,000.

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That’s great.

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That’ll reduce your federal Adjusted Gross Income (AGI).

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So that’ll save on your federal income taxes and in most states, that’ll flow down onto

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your state return and reduce your state’s Adjusted Gross Income (AGI) and save you on your

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state income taxes as well.

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But this begs the question, what about social security, Medicare, and the city taxes?

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Now the first [and only*] time that this happened to me, I did this because I had two HSAs.

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I had one that was provided to me at work, which was basically useless.

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It was just like a glorified checking account that gave me like 50 or 80 basis points of

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interest or something like that.

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And I had a second HSA at a brokerage firm where I was investing the bulk of my HSA funds.

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So when the new year rolled around, I had this genius idea of just contributing to my

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HSA at my brokerage account and investing it.

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And that was all cool until the next year when I sat down to do my taxes.

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So what tipped me off that I had a problem was I was filling out my city return and I

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was looking at it.

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I was looking at all the lines and I was trying to figure out how to get reimbursement for

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the city income taxes that I overpaid through my paycheck because they didn’t know that

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I had contributed personally to my HSA. And I couldn’t find it anywhere.

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So I contacted the city and I said, “Hey, you know, my Social Security and Medicare wages

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on my W-2 are artificially high because I made this personal HSA contribution.

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How can I reflect this on my city return so that I can pay the amount of tax that I would

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have paid had I contributed through payroll?”

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And they basically just told me to go pound salt.

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They said [paraphrasing], “You can’t.

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You know, if you contributed personally, that’s your problem.

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You’re not getting those taxes back.”

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So I kind of soiled my pants for a minute there because I was thinking, “All right, well,

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those taxes are gone.

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I wonder if I have a problem with Social Security and Medicare as well.”

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And then later I found out that, yeah, there’s no getting those taxes back either.

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So at the end of the day, that one mistake of contributing to my HSA through my bank

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account rather than through payroll cost me hundreds of dollars in extra taxes.

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And yes, I’m still salty about that.

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So learn from that mistake and don’t make it yourself.

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The fifth pitfall is over-contributing.

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Now that’s going to sound very obvious to most people, but this is an issue that can

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really sneak up on you if you’re not paying attention.

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There are several unforeseen circumstances that might cause you to accidentally over-contribute.

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For example, what if you or your employer changes insurance plans?

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Now I worked at a place once where our new health insurance plans started December 1st.

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So let’s just say, for example, that you contributed the maximum amount to your HSA for the year,

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sometime between January 1st and December 1st.

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And then for whatever reason, your employer decided to get rid of the HSA plan and go

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with something else.

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Well, you know, everybody knows what the yearly contribution limits are, but we need to understand

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is the contribution limits are actually determined on a monthly basis.

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So let’s just say for the sake of round numbers that your contribution, your yearly contribution

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limit was $3,600 a year.

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That’s $300 a month.

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Now let’s say you were only qualified to contribute for 11 out of 12 months of the year.

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That’s $3,300 for you.

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Now this can also apply to you, not just if your employer changes plans on you, but you

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know, what if you change jobs or what if you get fired?

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You know, your new employer might not offer an HSA.

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So if you’re one of these people that like to max out their HSA at the beginning of the

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year or something, you would run into a problem.

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I actually did this once.

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There was one year in January where I sent out, you know, the $3,500 or $3,600 or whatever

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it was to max out my contributions for the whole year.

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And then sometime after that, I was thinking to myself like, “Well, this is kind of risky.

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I mean, I could quit or I could get fired or whatever and I’ve already maxed out my contributions.”

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Now for me, that didn’t end up becoming a problem, but it could have.

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This is something to keep in mind as you contribute.

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And this is why we suggest to our clients that if they intend to max out their contributions

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for the year, that they avoid exceeding their contribution limit on a monthly basis.

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And you know, if you do over-contribute, it’s not the end of the world.

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It’s a little bit complicated, but basically you need to figure out how much you over-contributed

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by and work with your custodian to get it corrected.

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They’ll help you withdraw the excess contributions and they’ll perform some calculations to determine

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how much of your investment income from that period was attributable to your over-contributions.

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And naturally they’ll report that to the IRS so that you can be a patriot and pay your

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penalties on that.

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But still, you know, it’s a headache that you’re better off just trying to avoid.

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But like I said, avoiding over-contributing sounds really simple, but now we’re going

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to go over a few more examples of how this can really trip you up if you’re not paying

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attention.

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I worked at a place once and they said, “Hey, everybody, we’re going to contribute $200

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to everybody’s HSA account each year.”

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Now that’s not exactly what happened.

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What happened was they contributed $16.67 per month, which if you do the math

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that comes out to $200.04.

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So when I was doing my contribution planning, I took the yearly limit minus $200,

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and that’s what I was going to contribute.

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So technically, if I had done that, I would have over contributed by four cents.

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Now the question there is, you know, is the IRS going to harass you over four cents?

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And the answer is probably not, especially historically. But you know, now that they’re

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hiring 87,000 new agents, who knows?

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That’s just one of those things that you’re better off avoiding rather than finding out

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the hard way.

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Another thing that you’re going to want to be very clear on is if you get paid in arrears,

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you need to understand which year your employer is applying your January contributions toward.

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Because technically, they can apply those contributions either toward the year that January falls

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in or December of the previous year.

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Now most employers probably apply them to just the calendar year that they fall into,

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you know, like the date of the deposit of your contribution.

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But still, that’s something that you want to clarify, because that can trip you up.

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Also be aware that the family contribution limit only applies if you have a family insurance

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plan.

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So let’s say you’re a single parent and you have kids. You know, you might consider

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yourself a family, and you might be paying the expenses for your children.

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But as far as the tax code is concerned, if you’re on a single health insurance plan,

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you are subject to the contribution limit for a single person, not a family.

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And another thing that can cause you to accidentally over-contribute is if you have multiple HSAs.

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So before you get any bright ideas, no, opening multiple HSAs does not increase your contribution

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limit.

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You’re still capped at whatever it is, no matter how many accounts you have.

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So if you have multiple HSAs, just make sure that whatever you’re contributing to them

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in aggregate does not exceed your yearly contribution limit.

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And if you have multiple HSAs, multiple IRAs, or other tax-favored accounts (TFA), make sure you

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keep good records because it can be very difficult to keep all of this straight.

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The sixth and final pitfall that we’re going to talk about in this episode is under-contributing.

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Now just keep in mind, there are 11 of them, so we’re going to talk about the other five

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in Part 2.

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And this one is more of an opportunity cost, but just keep in mind that the contribution

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limits on an HSA are not very high.

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So for most people, it’s probably pretty unlikely that contributing the maximum amount

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each year is going to end up being more of a problem than under-contributing.

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And there are a few reasons why we would argue this.

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The first is that you’re probably not going to have an HSA every year for your entire

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career.

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So even if you contribute the maximum amount throughout your career when you have an HSA,

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it’s not really going to be that much money.

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And to add to that, just keep in mind that you cannot contribute to an HSA while you’re

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on Medicare.

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So for many people, they’re probably going to want to have, you know, a decent HSA balance

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by the time that they retire.

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So we think that most people should really, seriously consider contributing the maximum

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to their HSA while they can.

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And if you’re worried about over-contributing, and what I mean by that is just contributing

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more than you need, you know, in that it’s more than what your medical expenses are,

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not that you’re going over the contribution limits, you know, we would argue that technically

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you shouldn’t really worry about that either because when you do retire, your HSA effectively

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becomes a traditional IRA.

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So let’s say you retire and now you’re on Medicare and you’ve got $50,000 in your HSA

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that you don’t end up using for whatever reason, which is probably pretty unlikely.

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But even then you can distribute it as retirement income and you’ll have to pay taxes on that.

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But it’s not like your HSA becomes worthless once you retire or something like that.

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It’s still valuable.

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And like an IRA, in retirement, the funds that are in your HSA will continue to grow tax-free.

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Now that being said, we should mention that we’ve seen things like articles on the internet

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talk about using an HSA as a retirement plan, and it’s like some crazy hack that you should

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think about.

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We’re not a big fan of that approach.

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We see this as being something that’s kind of nice to have, but not something that you’re

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going to want to count on.

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So in other words, we don’t necessarily recommend treating your HSA like a retirement plan because

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the rules can change at any time, especially if we get into a situation where everyone’s

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crying to soak the rich or something.

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They might go on some kind of rampage to close a lot of these “loopholes”.

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00:20:46,960 –> 00:20:52,600
We saw something like this with, I believe it was called the Secure Act, which imposed

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new limitations on stretch IRAs and caused a lot of grief for some people who were counting

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00:20:59,000 –> 00:21:03,280
on the old stretch IRA rules for succession planning.

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So just keep that in mind and be careful.

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All right, that’s it for this episode.

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Make sure you stay tuned for Part 2, where we’ll go over the remaining five pitfalls

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00:21:13,200 –> 00:21:14,600
to avoid.

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I was just scrolling through the notes on that one, and it’s going to be a good one because

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00:21:18,720 –> 00:21:24,200
it contains more personal stories, like I’ll give you a little teaser.

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00:21:24,200 –> 00:21:32,640
One of these, my employer screwed up my contributions so badly that I had to get my 1099-SA and

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00:21:32,640 –> 00:21:36,040
5498-SA corrected.

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There’s also going to be some bonus material and words of wisdom for employers and employees.

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00:21:42,560 –> 00:21:45,720
So make sure you subscribe and keep an eye out for that.

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00:21:45,720 –> 00:21:49,320
And finally, consider becoming a Bigger Insights client.

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00:21:49,320 –> 00:21:54,160
We understand how overwhelming this stuff can be – so much so that some people may think

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00:21:54,160 –> 00:21:59,280
to themselves that HSAs and other tax-favored accounts (TFA) just aren’t worth the risk, but we

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00:21:59,280 –> 00:22:04,400
think that they are, and we can sit down with you in one-on-one sessions to help you take

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00:22:04,400 –> 00:22:08,600
advantage of the tax code and improve your financial situation.

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00:22:08,600 –> 00:22:13,720
If that sounds interesting to you, go to our website, biggerinsights.com, and fill out

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00:22:13,720 –> 00:22:18,040
the short form at the bottom of the page so we can schedule your initial consultation.

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All right, that’s everything.

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Thanks for staying until the end.

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00:22:22,040 –> 00:22:51,040
Don’t screw up your HSA, and have a great rest of your day.

Disclaimer

We are not CPAs, tax attorneys, or other tax professionals and nothing in this episode should be construed as tax, financial, health, or other advice. Shoeboxing HSA expenses, changing contribution elections, and investing your HSA funds involves risk, which may not appropriate to some HSA participants. Do not make changes to your HSA without first consulting your financial advisor. See our full Disclaimer for more details.

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