The Health Savings Account (HSA) stands out as a unique financial tool because they combine several tax advantages: contributions are tax-deductible, investment earnings grow tax-free, and withdrawals are tax-free when used for eligible medical expenses. This trifecta of benefits makes HSAs a hybrid of traditional and Roth IRAs. Like a traditional IRA, contributions are deductible upfront, and like a Roth IRA, qualified withdrawals are tax-free. Unlike traditional IRAs, HSAs do not have required minimum distributions, offering added flexibility and additional estate planning benefits.
Tax Implications for HSA’s and Accounts
It’s important to consider tax implications when comparing HSAs to other accounts. For instance, while withdrawals from taxable brokerage accounts may not be fully taxable, they often trigger capital gains. HSAs and 529 plans (for education expenses) must be used for qualified expenses to avoid taxes and penalties. However, HSAs provide an exception: after age 65, funds can be withdrawn for any reason without penalty, though such distributions are taxed like those from a traditional IRA. Distributions for qualified medical expenses are still tax-free in U.S. after age 65 and you have the added flexibility of taking additional distributions with no penalty.
One of the most notable features of HSAs is their “above-the-line” deduction, which has no income limits. This means contributions reduce your Adjusted Gross Income (AGI), making them accessible regardless of income level. This is not an itemized deduction, so it is also available to those who take the standard deduction. The HSA deduction is based on contributions which are separate from the medical expense deduction.
While IRA contributions are also above-the-line, they can be subject to income restrictions, especially if you or your spouse participate in an employer-sponsored retirement plan. For clients with high incomes or access to executive compensation packages, HSAs can be an valuable tool for tax efficiency. The primary qualification for contributing to an HSA is enrollment in a High Deductible Health Plan (HDHP). However, retirees on Medicare or those with employer-provided retirement health benefits typically do not qualify.
Provincial Healthcare Plans
For Canadians, HSAs present unique challenges. Provincial healthcare plans do not meet the HDHP criteria, and contributions are not tax-deductible in Canada. Even for dual residents, U.S. tax benefits are often negated by Canada’s higher tax rates and foreign tax credit systems. Moreover, HSAs are not recognized under the Canada-U.S. Tax Treaty, meaning investment income within an HSA is taxable in Canada.
For individuals moving to Canada with existing HSA accounts, it’s usually advisable to retain the account but use it for healthcare expenses in both countries as quickly as possible. Most medical expenses in Canada are qualified medical expenses as the same rules apply as the U.S. However, it’s prudent to deplete the account promptly upon relocation to Canada, as the following additional issues can arise:
- Tax Complexity: Since HSAs are treated as taxable accounts in Canada, tracking investment income can become burdensome. HSA providers do not issue tax slips for investment income, requiring you to manually calculate income, convert it to Canadian dollars, and categorize it for Canadian tax reporting.
- Limited Provider Options: Many U.S. banks no longer offer HSAs, and available options often have restrictions. For example, equity investment options may be limited, require a minimum balance, or freeze upon changing to a foreign address.
- Investment Constraints: If equity investments are unavailable, the small amount of interest income earned adds unnecessary complexity to tax filings. The additional tax filing expense may be more than the investment income you earn.
- Debit Card Issues: HSA providers may not send replacement debit cards to foreign addresses, complicating access to funds. Alternative methods such as checks or online transfers can be used, and receipts should be kept for medical expenses.
HSA’s vs. Resp’s
While HSAs offer unparalleled tax benefits in the U.S., their advantages diminish for Canadians due to cross-border tax treatment. As a result, keeping the HSA open for Canadian medical expenses is often better than closing the account and paying the penalty. Now that the investment income is no longer tax-free in Canada, the account is only complicating your life.
HSAs, TFSAs (Tax-Free Savings Accounts), and RESPs (Registered Education Savings Plans) share a common issue: they are not recognized under the Canada-U.S. Tax Treaty, leading to taxable investment income and complicated tax filings. It is important to note that TFSAs and RESPs no longer require the filing of form 3520 or 3520-A. Below is a comparison of the tax advantages of the various tax-free and tax-deferred accounts in the U.S. and Canada.
Cross-border lifestyles
If you navigate a cross-border lifestyle or have relocated between Canada and the U.S., it is crucial to consult with a cross-border financial specialist. We can help optimize your financial situation, minimize tax liabilities, and avoid the pitfalls of cross-border planning, ensuring your financial well-being across both countries. If you are crossing the 49th Parallel, reach out to us for help. From the Desert to the Tundra, we are your cross-border retirement experts.
