Can You Use an HSA to Pay Long-Term Care Insurance Premiums?

Updated

As the cost of receiving long-term care at a nursing home or assisted living facility continues to rise, so do premiums for long-term care insurance. Insurance companies are having difficulty keeping premiums in line with the increasing number of claims they’re paying every year as more and more baby boomers are receiving some type of long-term care.

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A health savings account (HSA) can potentially help pay long-term care premiums, which will be discussed in this article. But should you use your HSA to pay your premiums? We’ll also answer that question for you.

If health savings accounts are a new world to you, we’ll bring you up to speed on that, as well.

What Are the Benefits and Drawbacks of Using an HSA to Pay for Long-Term Care Insurance Premiums?

When it comes to paying long-term care premiums, every little bit helps. Using your HSA can be helpful in the short term but can cost you down the road. Let’s look at the benefits and drawbacks.

Benefits

Perhaps the most significant benefit of using your HSA to pay your long-term care premiums is that you’re paying with money that was never taxed when you directed that portion of your earned income to your HSA account. In other words, you paid with “pre-tax” dollars.

An HSA provides you with a “triple tax advantage:”

  1. Contributions can be made with pre-tax dollars via payroll deduction, and any contributions you make directly to your HSA could also be tax-deductible.
  2. Any interest or earnings from your HSA grows tax-free.
  3. You can pay for “qualified health care expenses,” including long-term care expenses and insurance premiums, tax-free.

Drawbacks

Paying your premiums with your HSA also comes with a big disadvantage: HSA depletion while you’re younger.

It may be nice to dip into your HSA and pay your long-term care insurance premiums today, but what will the effects be on you financially when you’re older and not earning as much as you did earlier in life? You may very well be wishing that you had paid those premiums out of pocket, so you had more money in your HSA when you needed it for long-term care or other medical expenses.

If you pay your premiums from your HSA, your account’s growth will be much slower because you won’t be earning as much interest or dividends as you could have if you left the money in your HSA.

For example, instead of taking $200 per month out of your HSA to pay your premiums, let’s assume you leave it there to earn interest, and you continue to deposit an extra $200 every month. Over 30 years, you’ll have deposited $72,000 into your HSA; and with that money earning compound interest at a rate of 5%, your account value would be over $175,000. You would never have had that incredible growth if you withdrew $200 per month for long-term care insurance or other qualified medical expenses.

When Are You Allowed to Use an HSA to Pay Long-Term Care Premiums?

You can use your HSA to pay long-term care premiums if your insurance policy is a “qualified long-term care insurance contract.”

In other words, your policy has to meet the following criteria:

  • The only insurance protection provided in the policy is coverage of qualified long-term care services;
  • The policy doesn’t pay or reimburse for any items or services that are reimbursable under Title XVII of the Social Security Act;
  • The policy must be guaranteed renewable (meaning that the insurance company can’t cancel your policy as long as you continue to pay your premiums);
  • The policy builds no cash value that can be borrowed or withdrawn (like some life insurance policies do); and
  • Any interest or dividends earned in the policy must be applied as a reduction in future premiums or to increase future benefits.

The good news is that almost all long-term care insurance policies issued today are qualified contracts.

When Are You NOT Allowed to Use an HSA to Pay Long-Term Care Premiums?

There are limitations on how much you can withdraw from your HSA each year, and those limitations are based on your age. These are the age-based limits for tax-free withdrawal from an HSA for long-term care premium payments in 2021 (consult your tax advisor, because the tax code changes often):

  • Ages 40 and under: $430
  • Ages 41-50: $810
  • Ages 51-60: $1,630
  • Ages 61-70: $4,350
  • Ages 71+: $5,430

If you don’t have an HSA or you don’t use your HSA to pay your long-term care insurance expenses, you may still be able to deduct your premiums from your taxes up to the age-based limits shown above.

If you withdraw more than allowed for your age bracket, you may face a 20% early withdrawal penalty and pay regular income tax on the amount withdrawn. 

How to Use Your HSA to Pay Long-Term Care Insurance Premiums

Now that you have your HSA set up and you’re taking advantage of all of the tax breaks offered, how can you use your HSA to pay your premiums? There are a couple of ways to do this.

First, you can use your HSA debit card to pay the premiums, though some insurers charge extra for accepting payment that way.

Second, you can withdraw money from your HSA, deposit it into your regular checking account, and pay the premiums from there. 

Can You Use an HSA to Pay Other Insurance Premiums?

Since many people believe that long-term care insurance is a form of health insurance, they mistakenly think their HSA can be used to pay their premiums.

For you to treat insurance premiums as qualified medical expenses, the premiums must be for:

  • Long-term care insurance (as discussed above)
  • Healthcare continuation coverage (COBRA)
  • Healthcare coverage while receiving unemployment compensation under federal or state law
  • Medicare and other healthcare coverage if you’re 65 or older (does not include Medicare supplement/Medigap policies)

How Can You Avoid Penalties On An HSA Withdrawal?

Since we’ve been looking at ways to get money out of your HSA to pay for long-term care insurance premiums, now is a good time to talk about avoiding penalties on all HSA withdrawals. 

The best way to avoid penalties on HSA withdrawals: use your HSA card only to pay for eligible purchases. You’ll have zero risk of penalties if that’s all you do.

You face two different types of penalties if you make a mistake withdrawing money from your HSA.

The first type is a tax penalty for ineligible purchases. For example, if you buy a new pair of shoes for $200 with HSA money, you’ll be paying income taxes on that $200. If your tax rate is 25%, that means you’ll be paying the IRS another $50. If you’re under 65, you’ll also be paying the 20% penalty ($40) on your early withdrawal. By misusing your HSA money, your $200 shoes just ended up costing you $290.

Remember, if that withdrawal is made to cover qualified medical expenses, there is no tax penalty. In other words, if you had bought orthotics that fit into your shoes, you wouldn’t have had to pay either the 25% income tax penalty or the 20% early withdrawal penalty.

If you’re 65 or older, you don’t need to worry about any penalties if you spend your HSA money on non-qualified medical expenses, like shoes, flat-screen TVs, or anything else you have your heart set on. However, since it’s a non-medical item, you will have to pay income tax on the HSA distribution. Still, it’s not a bad deal considering you put the money into the HSA on a pre-tax basis, and the money grew tax-deferred when it was sitting in your HSA.

Can I Also Withdraw Money From My FSA for Long-Term Care Insurance Premiums?

Unfortunately, you can’t use money in your Flexible Spending Account (FSA) to pay insurance premiums. FSA funds can be used to pay deductibles and copayments, but not premiums. 

Also, don’t forget that the money in your FSA should be spent by the end of the calendar year unless your plan allows you to roll over $550 (IRS maximum) if you’re unable to spend it. Your plan may also have a two-and-a-half-month grace period for you to use unspent funds, but your plan can’t do both. Your Human Resources department or benefits coordinator can let you know if your plan has either of these provisions.

You can contribute up to $2,750 to your FSA via payroll deduction in 2021. Your contributions lower your taxable income, which can save you money on your federal taxes. Your tax advisor can give you future contribution limits and the tax ramifications of your FSA.

Long-Term Care Insurance: The Forgotten Coverage

Long-term care insurance has been called the “forgotten coverage” because far fewer individuals have it than health, life, or disability insurance, and many companies don’t offer group long-term care coverage as an employee benefit.

According to many financial advisors and planners, the best time to buy long-term care insurance is when you are between the ages of 35 and 55. An independent insurance agent can provide you with multiple quotes on long-term care insurance when pre-planning for long-term care

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