Take advantage of a versatile Health Savings Account

Vedha Lekshminarayanan, CPA

If your employer offers a Health Savings Account (HSA) and you do not participate in it, you may be passing up an excellent opportunity to reduce taxes, boost retirement savings and even leave more to your heirs. Similar to 401(k) plans, HSAs are tax-advantaged savings accounts funded with pretax dollars.

Among the many benefits of HSAs is that funds can be withdrawn tax-free to pay for a range of qualified medical expenses. (Withdrawals for nonqualified expenses are taxable and, if you are under 65, subject to penalties.) Let’s look at the details and some best practices.

Follow the rules

Your HSA needs to be coupled with an employer’s high-dedu’ctible health plan (HDHP). For 2024, qualified HDHPs must have annual deductibles that are not less than $1,600 for self-only coverage or $3,200 for family coverage. Annual out-of-pocket expenses (deductibles, co-payments and other amounts, but not premiums) cannot exceed $8,050 for self-only coverage or $16,100 for family coverage.

You cannot participate in an HSA if you are enrolled in Medicare or covered by any non-HDHP insurance (for example, a spouse’s plan). Once you enroll in Medicare, you are no longer allowed to contribute to an HSA, but you can maintain an existing HSA and withdraw funds to pay for qualified expenses.

There are also limits on HSA contributions. For 2024, the annual contribution limitation for an individual with self-only coverage is $4,150. For an individual with family coverage, the amount is $8,300. There is an additional $1,000 “catch-up” contribution amount for those age 55 and older. Typically, contributions are made by individuals, but some employers contribute to their employees’ HSA accounts.

Reduce medical expenses

HSAs generally lower health care costs in two ways. First, they reduce your insurance expense (HDHP premiums are substantially lower than those of other plans) and allow you to pay qualified expenses with pretax dollars.

Second, any funds remaining in an HSA may be carried over from year to year, continuing to grow on a tax-deferred basis indefinitely. This is a huge advantage over health care Flexible Spending Accounts, where funds usually must be spent or forfeited. When you turn 65, you can withdraw funds penalty-free for any purpose (although funds that are not used for qualified medical expenses are taxable).

Leave assets for heirs

Unlike with traditional IRA and 401(k) plan accounts, there are not required minimum distributions with HSAs. Except for funds used to pay qualified medical expenses, your account balance continues to grow tax-free, adding tax benefits and providing additional assets for your heirs.

The tax implications of inheriting an HSA are different depending on who receives it. If you name your spouse as beneficiary, the inherited HSA will be treated as your spouse’s own. They can allow the account to continue growing and withdraw funds tax-free for qualified medical expenses. If you name your child or someone else as beneficiary, the HSA terminates and the account is taxed on its fair market value. In some cases, it is possible to designate your estate as beneficiary. Ask your estate planning advisor about the best course of action.

Retirement benefits

HSAs can be flexible tools. For example, if you save some of your account funds until retirement, you generally can use them for medical expenses or for housing, day-to-day living, travel, debt and other expenses. You might even use them to help pay for a grandchild’s education.

For more information, contact your ORBA advisor or Vedha Lekshminarayanan at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.

Two Tax-Wise Strategies for High-Net-Worth Investors

Ryan A. Kertes, CPA

There are so many considerations that go into buying a particular security or applying an investment strategy that it is easy to forget or forgo tax efficiency. However, for high-net-worth investors, some investments can generally help reduce tax exposure. Here are two.

1. Qualified Small Business Stock

For investors who meet the requirements, qualified small business stock (QSBS) offers an extraordinary tax break. When QSBS acquired today is sold, 100% of the capital gain up to the greater of 10 times the initial investment or $10 million is excluded from income, provided requirements are met.

QSBS was created more than 30 years ago by Internal Revenue Code Section 1202 as a tax incentive for investments in “small” businesses. Initially, 50% of the gain was tax-free, but Congress raised the exclusion to 75% for stock issued after February 18, 2009, and to 100% for stock issued after September 27, 2010. Sales of QSBS are also exempt from the 3.8% net investment income tax and, for stock issued after September 27, 2010, from alternative minimum tax.

The tax incentive typically is available for qualifying QSBS issued after August 10, 1993. However, shares must have been issued by:

• A domestic C corporation whose aggregate gross assets were $50 million or less at any time after August 10, 1993, and immediately after the stock was issued;
• An active business, meaning it uses at least 80% of its assets (with certain exceptions) to conduct one or more active businesses; and
• An eligible business. Ineligible businesses include those involved in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, banking, insurance, financing, leasing, investing, farming, oil and gas, mining and hospitality.

The tax break is available to individuals and trusts, as well as certain pass-through entities. To qualify for the exclusion, investors must acquire the stock directly from the corporation or an underwriter in exchange for money or property. They (or their heirs) must hold the stock for at least five years.

Note that there are some disadvantages to owning QSBS. Investments in small companies can be risky, so it is important to weigh those risks against potential rewards. Also, the five-year holding period can cause investors to hold the stock longer than they would otherwise, potentially losing early gains should the stock’s value then decline. There is also a risk that the benefits will be lost if, for example, the company ceases to meet the active business requirement.

2. Exchange Funds

It is not unusual for investors to end up with heavy concentrations of certain stocks in their portfolios. This can happen if, for example, you inherit a large block of stock or receive stock shares when you sell a business. In such situations, you may wish to rebalance your portfolio, but could be concerned that rebalancing would generate sizable capital gains taxes.

One potential solution is to take advantage of an exchange fund (or “swap” fund). These funds allow investors to swap their concentrated stock holdings for shares in a diversified fund, without triggering capital gains tax. Exchange funds invest in a diversified mix of stocks — they are often designed to track the S&P 500 or another market index — potentially reducing investors’ overall risk.

Keep in mind a few caveats. Exchange funds are usually restricted to “accredited” investors with substantial investable assets. Also, assets will be tied up for a seven-year holding period.

Beyond taxes

You should never make investment decisions based on taxes alone, but tax efficiency can be a critical factor. Your advisor can help you evaluate these and other strategies for making your portfolio more tax-efficient.

For more information, contact Ryan Kertes at [email protected] 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.