Benefits of the Front Page

It’s that time of year again:  while some may think we might be referring to the Masters’ Golf Tournament (maybe our favorite sporting event, coming up in a few weeks), we’re actually referring to something much less pleasurable:  income tax filing.  This year, the deadline is April 18th and for many people it’s annoying at best and downright terrifying at worst.masters image

Without proactive tax planning, most people are staring at either a Turbo Tax screen or their accountants’ mystifying tax documents and ultimately just want to know one thing:  “Will we have to write a check to Uncle Sam or will I be getting some cash back?”

It doesn’t have to be this way.  In fact, as integrated financial advisors we think it’s prudent to always be cognizant of federal and state income taxes, typically our clients’ largest expenditure each year. (DISCLAIMER:  We are not CPAs, nor enrolled agents so this should not be construed as formal tax advice as all families’ tax situations are different.  You should consult your CPA or enrolled agent for specific tax advice.)

tax guyEven though we are not CPAs nor enrolled agents we still partner closely with CPAs to ensure our clients are always compliant with tax laws and regulations.  This means our CPA-partners fill out tax forms, research the applicable issues, sign the returns and work with tax authorities, if necessary.

As financial advisors, nobody is more involved in our clients’ financial lives. For this reason, we believe staying sharp on taxes throughout the year is essential, and potentially profitable, for our clients.   Realizing this, we always try to employ what we think might be an underappreciated approach to tax planning:  the “front page” deduction.

“Front page” deductions are those tax deductions that actually lower AGI (adjusted gross income) on the “front page” of the federal tax return (Form 1040).  These tend to be more “valuable” because they can positively impact other parts of the tax return, much more so than the typical, and similar, “Schedule A” deductions (a.k.a. itemized deductions).  Why is this?  In general, because other Schedule A deductions use the AGI number as the basis to determine how much of these expenses can be deductible.

For example, if you have lower AGI you could see a larger tax deduction for:

  1. out-of-pocket medical expenses
  2. miscellaneous deductions (such as financial planning and tax preparation fees)
  3. casualty losses and others

In addition, you could also lower the amount of social security income that would be taxable (assuming you are currently taking social security).

But the trick is to lower the AGI in order to benefit more from those deductions.  This can be accomplished by employing the “front page” deductions.  For instance, instead of contributing to a charity and deducting it on Schedule A, maybe our retired clients should use a Qualified Charitable Deduction as part of their IRA required minimum distribution.  Also, as financial advisors we keep a sharp eye on those investment accounts and try to offset capital gains with capital losses during the year so as to either lower the capital gain income (on the front page) or maybe even maximize the $3,000 annual allowable capital loss.  Other examples include contributing to Health Savings Accounts and ensuring all expenses for a small business are fully (and legally) recognized as offsets to income.

This may all sound too nerdy for some but if we illustrate with an example, you may sit up and take notice at the material tax savings which could be realized by knowing how to employ these strategies.

Let’s say we have a retired married couple with the following gross income totaling about $118,000

  • $8,000 of interest & dividends
  • $5,000 of capital gains
  • $50,000 of IRA distributions
  • $40,000 of Social Security income ($34,000 taxable)
  • $15,000 of consulting work income

And let’s say they have the following expenses, some of which are deductible:

  • $10,000 of out-of-pocket medical expenses ($300 is deductible because their income is so high)
  • $8,000 of real estate taxes
  • $10,000 of charitable contributions
  • $7,500 of tax and financial planning fees

Overall, we estimate this couple would owe about $10,372 in federal income tax or about 12.8% of taxable income – not too shabby.

But, what if we made the following changes (with all other deductions remaining the same) with “front page” deductions to lower our AGI and the tax burden?

  • Make a QCD (qualified charitable distribution) to donate the $10,000 directly to charity from our RMD instead of donating from our checking account and deducting on Schedule A
  • Maximize the contribution to the HSA (if qualified) and pay most medical expenses with these funds
  • Incorporate a tax-loss harvesting strategy in taxable investment accounts to deduct the maximum $3,000 capital loss each year
  • Document and deduct $5,000 of expenses related to the consulting work

By making these changes, we have lowered our taxable income from $80,640 to only $50,246 which means our tax bill is now only about $5,841 – an annual savings of over $4,500!

In our minds, this illustrates the difference between financial planning and having “an investment guy”.  Sure, it may not be the latest & greatest stock tip (which usually crashes & burns anyway) but tax savings is real cash flow.  In addition, these savings can compound year after year adding materially to families’ net worth.

The point is this:  taxes can be confusing, boring, scary and annoying all at once.  But knowing how the 1040 tax return works can add substantial value when combined with prudent investment advice. This is why when we meet with our clients on the various financial topics throughout the year, we always have our ears open for how to lower that AGI and potentially lower the tax liability, putting real money back in our clients’ pockets.

Comments?  Questions?  Feel free to enter them below and we’re happy to address.

Trump, Taxes and You

By now we should all have digested the surprising results from the most recent election on November 8th.

Some of us may be rejoicing and some of us may be despondent but whatever side of the political spectrum you’re on, it’s now time to deal with the reality of the situation:  Donald Trump will be inaugurated as the 45th President on January 20th, 2017 and the Republican Party will hold majorities in both the House and the Senate for at least two years.

As we wrote in our most recent blog, the best way to deal with the results is to “control what we can control” as it relates to our financial lives.  This means adding value in our careers, optimizing investment strategies & tax strategies, etc.

But now that we know the results of the election- what can we actually do in more tactical terms?  How should we be thinking about 2017 and importantly- should we be doing anything before the close of 2016?Trump & Taxes

We believe the most immediately applicable policies to consider center on taxes. While there are many moving parts and multiple proposals from Trump and the Republican congress, at least we do have some hard numbers that could (we emphasize could) be implemented in 2017.

These are:

  1. Income Tax Rates: Rates on “ordinary income” could be flattened from seven brackets to three (12%, 25% and 33%). The 33% top rate would be lower than the current 39.6%.
  2. Deductions: Both Trump and Paul Ryan (Speaker of the House) have announced plans to limit deductions in size (i.e. put a cap on the total dollar amount that can be deducted) and type (i.e. eliminate what is considered deductible). This could partially offset the impact of lower rates.
  3. Capital Gains: Trump’s plan is to keep the current rates in place (0%, 15% and 20%) while Ryan’s plan raises them slightly.
  4. Alternative Minimum Tax: Both Trump and Ryan propose eliminating the dreaded AMT.

If these tax policies were to become reality, it has a few implications for near term tax planning.

First, for high earners (Married Filing Jointly, above $231,450 in taxable income) this means the value of any deductions could be higher in 2016 than it might be in 2017, all else being equal.  So as you look at your tax projection before year-end, you should seriously consider “pulling forward” any itemized deductions such as charitable donations and real estate taxes as you could have lower rates in 2017.

Second self-employed individuals may want to consider deferring some income (in a legal manner) to 2017 and pulling forward (and deducting) some business expenses so as to reduce 2016 taxable income.

Aside from taxes- what else should we consider?

Trump and the Republicans firmly believe that lower tax rates do not necessarily mean lower tax revenue for the U.S. Treasury, as the lower rates applied to a faster growing economy have historically resulted in higher income for the federal government.    This worked for Kennedy (a Democrat), Reagan and George W. Bush in recent decades.

A faster growing economy could also ignite inflation, which could also mean higher interest rates. In fact, the bond market seems to already be anticipating this scenario as yields on US Treasuries have ascended rapidly since the election.  Unfortunately, the puts-and-takes around interest rates and investments is a whole other topic for another time.

Overall, we view the Trump/Republican agenda as generally pro-growth.  But this could always be countered by some growth constraining policies from a President Trump like a potential trade war (with Trump’s much discussed tariffs) which could dampen growth.  In addition, we are dealing with a truly unique President-elect (never been elected to any office) with a track record of unpredictable and sometimes outrageous behavior.  So there is always the possibility of some out-of-left field action that can’t be blocked by Congress (like crazy treaty negotiations or cancellations) that could have a deleterious market reaction.

Bottom line:  We view the near term political landscape with a positive bias given the pro-growth agenda, underscored by the aggressive tax reform.  In this context, we should all be vigilant in our tax planning for 2016 and into 2017.  Aside from this, we should maintain our focus on what we can control (factoring in the new information) while the politicians slug it out in D.C.


What We’re Watching In The Upcoming Elections

election-imageThe recent cooler temperatures in Northeastern Ohio seem to have flipped the switch as the unofficial ramp-up of an already heated election season.  As we all know, this culminates on November 8th with the election a new president along with many other congressional representatives.

So as financial planners, why would we articulate our observations about this divisive election? Are we really going to get political and make an argument for either Trump or Clinton?   Of course not.  We are old enough to know it is usually pointless to argue politics with someone who already has their mind made up.  Even if you think you have an open-and-shut case for a particular position with facts and figures to back you up, we’ve learned that it just doesn’t matter.  If someone is entrenched in a particular mindset, they just can’t be convinced otherwise.

That said, we have had enough recent conversations with nervous clients (on both sides of the political spectrum) who are convinced “If Trump/Clinton get elected, we’re in big trouble!!!”  While that may be true, we can all at least agree that one of these two candidates is almost guaranteed to take the oath of office in January.  So we’re stuck with one of them.

For this reason, it’s important to be cognizant of the each candidate’s positions on taxes, trade, fiscal policy along with many other issues.   So we do need to educate ourselves on Hillary Clinton’s estate planning tax proposals and capital gains tax changes.  And we do need to know about Donald Trump’s compressed tax brackets and repatriation tax rates.

However, we think individual investors have a tendency to put too much focus on the outcome of the presidential election.


First, in our view most of these proposals serve mostly as political grandstanding.  We think most “new policy” speeches are nothing but grandiose ideas that make for nice sound-bites for the mass media, newspaper headlines, Facebook posts or Twitter hashtags.  They are almost always short on detail and there’s never really any deep discussion on how these plans would be implemented or if they are even feasible.

Which brings us to our second point- most of these proposals will never be implemented because they will never see the light of day if they aren’t passed first by Congress.  Now we don’t mean to bring back nightmares from your high school civics class but our republic has a system of checks and balances.   Laws, and more importantly, spending cannot be authorized without first passing through the House and Senate.

So what we are watching most intently is the interaction between the presidential outcome and congressional races.   As most know, currently both the House and Senate are held with slight majorities by the Republicans controlled as a result of the huge gains from the 2014 mid-term elections.

So there are four most likely outcomes:  Trump elected with a Republican congress, Trump Elected with a Democrat congress, Clinton elected with a Democrat congress and Clinton elected with a Republican congress.

In our view, any opposition of presidential party & congressional majority party (i.e. Clinton with a Republican congress or vice versa) would mean most of these presidential proposals will have little chance of full implementation.

However, if we see the same party come out victorious in both the oval office and on capitol hill, we need to watch very closely how proposed new policies would impact our investments, taxes, insurance planning and estate plans.  So what half of the country may think are crazy ideas may very well become law and could have very real impacts on economic growth, stock and bond market returns and of course, how much we pay Uncle Sam on tax day every year.   But even then, these changes won’t happen overnight, so kneejerk reactions to asset allocations or tax strategies usually does more harm than good in the long run.

Write the Check or Cash the Check?

Now that the official tax filing date has passed, most of us usually have one of two mindsets relative to this onerous process.  If we’re getting a refund, we’re happily waiting for the check or the direct deposit to hit our bank account.  We may have visions of new patio furniture or paying off that high-interest credit card balance.  But if we owe taxes, we’re not so happy to have scratched that check to Uncle Sam, our State treasurer or the local tax man.  As we dropped that check in the mailbox, we might have been thinking “What does my congressman do all day anyway?” or “Why can’t they repair that massive chuckhole at the end of my street?”Uncle Sam Shakedown

In either case, a question I often get this time of year is whether it is more advantageous to get a refund or to owe taxes when it’s time to file a return.

Like most financial planning questions- there’s a “hard numbers” answer and a subjective answer but let’s run through each scenario.


In the most basic terms, if you’re receiving a refund this year, this means you endured some combination of over withholding from your wages and/or business income this year and/or you paid estimates during the year that exceeded your liability- pretty simple.

So the government owes you your money back.  No doubt, getting a check/direct deposit for several thousand dollars always puts a spring in our step this time of year.  And I believe this “miscalculation” on the estimate stems from the fact that the tax filing process itself is such a quagmire.  The complexity around income tax returns results in a “black box” where we really don’t know with a high degree of certainty how much of a tax liability we’ll actually incur during the year unless we sit down at least once during the year for a detailed tax projection (which I walk through with almost all my clients).  This means we “overcorrect” and pay more in taxes throughout the year in anticipation of this “refund”.

But in my opinion, we’re really just fooling ourselves.

As most have probably heard it described, this refund is effectively an interest free loan to the government during the year and I don’t know about you, but lending money to the government is not high on my priority list.


Obviously, the inverse of the refund scenario means your tax liability is higher than the payments you’ve made via withholding and/or estimate payments during the year.  Again, the primary reason for this is usually related to the difficulty in navigating the tax code to properly estimate the year-end tax liability.

What some people don’t realize is the federal income tax is a “pay as you go” tax. This means that the onus is on the taxpayer to pay tax on income earned throughout the year – either through direct withholding from your paycheck or by making estimated tax payments.  The key is the timing of when you pay the required tax because you can’t just calculate the annual tax owed and write a check on Dec 31st or April 15th.

If you don’t pay enough each quarter, then you may get an unexpected tax bill after filing your tax return for penalty and interest on the underpaid amount. While the calculation (not surprisingly) is somewhat convoluted, the current interest rate on the under-payment amount is 3% and the penalty is 0.5% per month in addition to the interest.  In most cases, the penalty and interest probably doesn’t add up to an exorbitant amount, though it could be consequential if you are self-employed or if you receive a large inflow of taxable income without withholding.

In general, the underpayment penalty does not apply if:

  • You owe less than $1,000
  • You paid at least 90% of the tax owed for the year, or
  • You paid at least the same amount of total tax as you paid for the prior tax year – this requirement increases to 110% if your adjusted gross income is more than $150,000 (or $75,000 if married filing separately).

Again, this is where detailed tax planning comes into play well before filing the tax return.


In my opinion, the optimal scenario is to determine proper withholding that is likely to result in a small liability at tax time.  This can be accomplished with proper tax planning and a mid-year tax projection that factors in bonus payments, adjustments to portfolios (capital gains & losses) and a myriad of life events impacting a tax return.  Of course the primary reason is to keep our money in our own pockets and not rely on the government as a de facto bank.  Optimally, your paychecks should be coordinated with tax withholding and integrated with an automatic savings program (direct deposit to YOUR savings account, not the government’s) and a proper liquidity strategy with ample funds to handle any “surprises” when it comes to filing taxes.

As noted above, the risk to incurring tax penalties is relatively minor (especially with a little planning) so it makes much more sense to take this small “risk” of owing some tax in April.

Yes it’s nice get that check/direct deposit in April and yes, it’s easy to think of this as some sort of windfall.  But in my mind, I’d much rather look at a savings account statement from April of last year and compare it to April of this year and take heart that I had access to this money when I wanted it – not when Uncle Sam gets around to paying it back.



Appreciating the NUA

office spaceWhen it comes up in casual conversation that I am self-employed, people usually picture the clichés of “going to work in jeans” and “setting my own hours” often associated with self-employment.  While some of that is true, I often tell people being self-employed has a lot of advantages but also a lot of disadvantages.  Without going into a laundry list of advantages & disadvantages, I will say one of the things I miss about working for a large company is the ability to fully participate in what is often a generous matching program with 401(k) retirement savings programs.  This is the percentage “match” of pre-tax contributions that is essentially free money and is a no-brainer when it comes to saving for retirement.

While some companies use good ole’ cash as the asset to match employer contributions (my preference), some employers instead match in the corporation’s stock which could help or hurt you (depending on the stock performance) but in either case, this matching in stock introduces some complexities when it comes time to retire.  Specifically, if an employee amasses a large position in employer stock after years and years of contributions and “autopilot” matching, they may suddenly find themselves WAY overleveraged to a single company’s stock in what should really be a relatively conservative portfolio just before or in retirement.

So what is one way to “fix” this in a tax-advantaged way?  Enter the NUA (net unrealized appreciation).  (Obligatory disclaimer:  I am NOT a CPA so please consult your CPA or enrolled agent before making any final decisions on this strategy).  The net unrealized appreciation is a way to take the stock “in kind” as part of a lump-sum distribution and moving that stock in to a taxable account.  The primary reason?  In short, to take advantage of what are presently lower capital gains tax rates compared to ordinary income rates.

Now there are a lot of moving parts around this and each person has individual circumstances that could sway the decision to do this one way or the other but in my view, the strategy is at least worth investigating as it could save a retiree a bundle on income taxes over a long period of time. (Note: the distribution must be the entire balance, in a single year, from the employer’s plan and the employee must be paid after age 59 ½ or separated service, disabled or dead.  See?  I told you there were a lot of moving parts- that’s just the tip of the iceberg.)

So here’s how this works.  Let’s say someone has worked at company XYZ for 35 years and in that time has accumulated a large position in the shares by buying some shares outright within the plan and also getting the “match” with the shares.  Assuming the stock has gone up over the last 35 years, this means they have many shares at a low cost-basis (price they paid) compared to the current stock price.  The NUA allows someone to take the distribution but only be taxed at ordinary income rates on the cost basis and NOT the fully appreciated value.

So if someone had $1,000,000 in XYZ and a cost basis on all their shares at $200,000 they would distribute the shares and pay ordinary income tax on only the $200,000 in the year of distribution while the remaining $800,000 of stock would now be in a taxable account and would not be “required” to be withdrawn like with an RMD on an IRA.  While that tax bill on the $200,000 is nothing to sneeze at, it could be much lower over time than rolling over the full $1,000,000 to an IRA, then taking distributions (for living expenses) and paying ordinary income tax rates on all those larger distributions.  To put some real numbers around this, a married couple filing jointly pays a 28% marginal tax rate on income between about $151,000 and $230,000.  So assuming they paid a blended rate of maybe 25% the year they take distributions (due to other income) that would be a tax bill in the first year of $50,000 (25% on $200,000).  However, they would now have a smaller IRA ($200,000) and a larger taxable stock account ($800,000) that they are NOT required to take distributions on and when they do, they would sell for the stock and pay capital gains rates, which for most would be about 15% on the gain.

As I stated, there are many other restrictions and moving parts associated with this decision including age, other income sources, dividend yield on the stock, plans for heirs, opinions on the future performance of the stock, etc.  So the purpose of my article is not to necessarily diagnose a personal situation because everyone is unique.  In fact, I had a client in this exact scenario and due to some unique circumstances we actually chose NOT to employ the NUA.

The point is to drive awareness that this strategy exists in the dusty, cob-webbed sections of the tax code and should be seriously considered.  This analysis requires some long discussions, some geeky spreadsheets (which I happily create) and some tough calls.  But if you do find yourself in this unique circumstance of high exposure to low cost-basis employer stock in your employer’s retirement plan and you’re thinking about retirement soon, I implore you carefully evaluate this strategy.  So as an employee of a big company, you may have not been able to “create your own hours” or “wear jeans to work”.  But – the ability to fully utilizing the NUA (if appropriate) could potentially help turbo-charge the value of all those years “punching the clock”.

Writing a Check to Save Some Money

Given all our techie options for paying people these days, writing a check seems almost quaint doesn’t it?  Much like the hand-written “thank you” note (which I still appreciate), the process of getting out the checkbook, writing the check, recording it in the register (hopefully), putting it in the envelope and stamping it with postage seems to be an anachronistic practice found in some rejected Norman Rockwell painting and not for anyone today with a laptop and/or tablet.

But before the calendar flips to 2015, I believe doing some simple math and scratching out a check or two could save a family some cash when tax-filing rolls around this coming April.  How?  By employing a strategy called “bunching deductions” and legally taking advantage of deductions to your income this year, instead of next year.

How does it work?  In reality, it’s a two-year strategy and it works best for taxpayers who have total deductions that approximate the standard deduction every year on their tax returns (For 2014, the standard deduction is $12,400 for joint filers and $6,200 for individuals).

As a refresher, taxpayers have the choice every year to either itemize their deductions (a.k.a. add them up and subtract them from income) OR take the standard deduction against their income.  So if a family has $200,000 of AGI (adjusted gross income) and their deductions only add up to $11,000 they are obviously better off subtracting the larger standard deduction ($12,400) in order to minimize their taxable income.  Of course if they have deductions that total over $12,400 they are better off itemizing and reducing their tax burden.  But what if we could “pull ahead” some deductions for one year, itemize and take the higher deduction amount, then take the standard deduction the following year?  Well, we can and we should!

Let’s use an example to illustrate:  Let’s say every year, Joe & Mary Taxpayer have AGI of $200,000 file jointly and pay about $5,000 in real estate taxes, $3,000 in mortgage interest, $3,000 in state & local income taxes and contribute $1,000 to charity.  These are all deductible expenses and total $12,000.  Given the standard deduction is $12,400, they are better off taking the standard deduction.

But they could “pre-pay” a few of next year’s deductible expenses this year: namely real estate taxes and charitable deductions.  Instead of paying those same amounts every year, they contribute an extra $1,000 to the charity (doubling the 2014 contribution) and pre-pay the extra $5,000 in real estate taxes before the end of the calendar year and their deductions for 2014 now total $18,000.  So they are effectively benefiting from $5,600 of extra deductions ($18,000 – $12,400 standard deduction) which at a 28% marginal tax bracket saves them just over $1,500!  Then, fast forward to 2015: they don’t contribute to the charity (because they already did) and don’t have to pay the real estate taxes and their deductions are now only $6,000 (state and local taxes and mortgage interest) but they can take the standard deduction of $12,400!

Of course to accomplish this, the taxpayers must have enough cash in the bank to finance this extra payment- yet another example of why I recommended a solid base of liquidity to all clients.

As an added kicker, for a couple in that income tax bracket, they are starting to get phased out of other tax advantages (i.e. Roth IRAs, Traditional IRAs and various education deductions) so any time we can save some money on taxes, it’s a welcome break from Uncle Sam.

Bottom line:  Before starting your New Year Eve celebration (or barely making it to midnight, which is how I usually celebrate) it might be a good idea to do some quick math, dust off that checkbook and write an extra check or two. Ironically, writing those checks could save you some money.

Merry Christmas, Happy Holidays and Happy New Year!!

The Under-the-Radar Retirement Account

“We interrupt this article posting for a brief comment on the recent stock market decline…..”

I wasn’t going to write about the recent decline in the stock market but given the volatility of the moves over the last several days, it probably bears some mentioning.   For those who don’t know, the S&P 500 index (broad measure of stocks) has declined about 5.4% since October 8th.  So what’s going on? From my own research it appears the sell-off is being driven by new fears that the global economy (mostly outside the US) is weakening combined with the fact that we will no longer have the benefit of the Federal Reserve’s “backstop” of their various interest rate-suppression tactics. Adding to these issues, is a general accumulation of negative sentiment building up with geopolitical concerns (ISIS advancements, Russia-Ukraine conflict) and the uncertainty around the ebola virus.

However, my take is this is probably more of move in step with a “normal” market rather than the exception.  By that I mean we have been through a multi-year period of low volatility and amazingly consistent gains.   So most recently, we’ve been conditioned to believe sharp moves down are not common.

As individual investors, we must keep in mind a few things. First, we must have our portfolios aligned with the time-frame for which we will need the money.  If you need money next week for a down-payment on a home, you probably shouldn’t be fully invested in the stock market.  Conversely, if you have 40 years until you retire you can probably afford to take more risk by investing in stocks, no matter what they’re doing this week.  Second, what’s often overlooked is that many “safe” bond prices have actually increased in value (as noted by the drop in yields), which speaks to the value of a diversified portfolio.

In a nutshell, I don’t know what the stock or bond market will do tomorrow, next week, or next month. But over the next 20+ years, I believe it is worth the risk to invest in a diversified, low-cost portfolio of assets that have a solid track record of growth in our country.  So we should all focus on controlling what we can control:  spending less than we earn, diversify, keep investment costs low and minimize our tax liability (legally).

Now onto my “regularly scheduled” article……

The Under-the-Radar Retirement Savings Account

I know it’s hard to believe but the Halloween decorations adorning our neighborhoods are a friendly harbinger of the close of the calendar year, which will be upon us in a couple months.  Of course the inevitable rush of the holidays will also be upon us (as indicated by the Christmas trees already on sale at Lowe’s), which can certainly shift financial planning topics to the back burner.

However, it’s important to use this time before the end of the year to optimize our income tax liability by taking advantage of any & all deductions for which we are legally eligible, which includes contributions to IRAs and/or 401(k)s.  But the merits of maximizing contributions to the retirement accounts are generally well known.  This is why today I am detailing what I believe is an under-the-radar but very effective income tax saving strategy for high-income earners that is easy overlooked.  What is it?  Your HSA (Healthcare Savings Account).

Why?  Because it’s one of the few income tax advantaged accounts NOT phased out by earning high income.   So let’s start with what HSAs are, the restrictions and why I think they could be considered another de-facto retirement savings account.

HSAs Defined: HSAs are personally owned “bank accounts” (for lack of a better term) which hold funds used to pay qualified medical expenses for the account owner.  Contributions to these accounts are tax-deferred, which means you get to deduct it from your income.  If you withdraw funds for anything other than medical expenses, the funds are taxed as ordinary income and may be subject to an additional penalty.  If / when you leave your employer or retire, you keep your account and all the funds in it.

HSA Eligibility:  To be eligible to use one of these accounts, you must participate in a “high deductible” health care plan with your employer.  If you’re self-employed, or self-insured you are subject to the same stipulation.  According to the IRS, this means your plan must have an annual deductible of $1,250 for self-only coverage or an annual deductible of $2,500 for family coverage. There are also maximum out-of-pocket limits with the plans, which are $6,350 for self-only coverage or $12,700 for family coverage.

HSA Contributions & Usage Restrictions: Account holders for self-only coverage can contribute and deduct $3,300 per year while family-coverage account holders can contribute $6,550 per year.  If you’re 55 or older, you can add $1,000 to those amounts (totals $4,300 and $7,550 respectively).  Big Caveat:  Any contributions by you to another medical account (Medical Savings Account) or contributions from the employer, reduce these contributions dollar-for-dollar. So if you are 50 years old and your employer kicks in $2,000 to your HSA, you can only contribute and deduct $4,550 ($6,550 – $2,000).

  • Qualified Expenses: Basically, you can withdraw and use the funds any time for qualified medical expenses. Qualified expenses are un-reimbursed medical or dental expenses for the taxpayer, spouse and dependents including prescriptions.  Health insurance premiums are not qualified unless for COBRA, Long Term Care or if you’re unemployed.

The Math Behind the Advantages of HSAs:  The way I see it, there are two big advantages to HSAs- one before retirement and one during retirement.

  • Before Retirement: Before you retire, you can contribute funds to the accounts and save on your income taxes.  For example, if you contribute $5,000 per year and you are married with over $200,000 of adjusted gross income, you would save about $1,400 in taxes every year.  But here’s the rub:  If you make this much money, you have VERY FEW deductions available to you but, the deductions for HSAs are NOT limited by income!  If you think you’ll ever need to spend money on medical expenses (which we all usually do), this is a GREAT thing to employ in my opinion.
  • During Retirement: One of the little-known provisions of the HSA is that when the account holder is eligible for Medicare (usually age 65), they can withdraw the money and use it for ANY reason without the penalty. It is still taxable as ordinary income (like an IRA distribution) but what this means is that you effectively have a tax-deductible IRA-like account with funds that can be used for any reason when you’re eligible for Medicare!  In my view, it’s a great deal.

Bottom Line:  People who earn upwards of $200,000 and more annually have very few available tax deductions that aren’t “phased out” and therefore out of reach.  If you’ve worked hard enough to earn that kind of income, you have access to an HSA and you think you will someday need to spend money on medical expenses (won’t we all?) you should consider maxing out your contribution to an HSA.  Not only will you save on income taxes while working, you’ll also have another pool of money from which to draw in your “golden years”.