Want a sweet last minute tax break? Contribute to your Health Savings Account.
Not too long ago I sat down with my accountant to prepare my taxes. After looking at my situation and running the numbers, he told me I could save right around $2,000 in taxes by maxing out my HSA contributions.
I love my Health Savings Account. Not only is there a tax deduction involved, but the money can be withdrawn tax-free at anytime, as long as you use it for qualified health care expenses. You get a tax deduction and your money grows tax-free.
However, I haven’t been taking advantage of the ability to contribute to my HSA as I should, and my accountant pointed out to me that I could but putting that money to better use. And, because of the way the HSA works, I got a last minute tax break, lowering my tax bill — even though my contribution was made well after December 31.
HSA Contribution for a Last Minute Tax Break
There’s nothing more last minute than a tax break you can claim after the end of the year. As with the Traditional IRA, it’s possible to contribute to your Health Savings Account for the previous year until tax day.
For 2013, the contribution limit for a family was $6,450 (for 2014 it’s $6,550). I contributed throughout 2013, but I didn’t come close to maxing out my contributions, because I didn’t plan it. Instead, I just moved money into the HSA when I thought about it. No automatic transfers.
No real plan for the money.
Not the smart approach for a personal finance writer (or anyone, for that matter).
In order to claim the deduction, all my contributions need to be made by April 15. In order to properly assign the contribution, though, it’s important to specify that you are making a “previous year” contribution.
If you send the contribution in by check, call your custodian to find out how to send in the check. You might need to fill out a form, or write something specific on the memo line. When you take care of it electronically, there is often an online checkbox. Before you hit the “submit” button, you want to make sure that you truly have checked the correct box.
It’s important to specify which year the contribution belongs in, since over-contributing in one year can lead to penalties. It’s better to make contributions throughout the year for cash flow reasons, than it is to make a last minute contribution. However, if you’ve run the numbers and you can benefit from a last minute tax break, and you have the cash to make it happen, you might as well take advantage of it.
$4,000 Deduction = $2,000 Tax Savings
The “value” of your deduction depends on the tax break in question, and where you stand in terms of your tax bracket. It is important understand that a tax deduction is different from a tax credit.
A deduction reduces your tax liability by reducing your income. A credit is more valuable, though, because it’s a dollar-for-dollar reduction in what you owe.
As you can see with my example, just because you claim a deduction for $4,000, it doesn’t mean that you are going to reduce your tax liability by that much. In fact, depending on your situation, you might not even end up with a 50 percent tax savings. I managed it, because of my position on the edge of a tax bracket.
However, even though I didn’t reduce my tax liability by the amount of the deduction, it was still a “good deal.” The $4,000 I contributed to the HSA is mine. It will grow tax-free over time. So, instead of paying almost $2,000 to the government, I put a little more than $4,000 into my own account.
This reality is true when you have the chance to take advantage of any other last minute tax break. If you can put the money to work for you in some way, even if the account is tax-deferred instead of growing tax-free, it’s a more efficient way to build wealth.
This year, I’m make a plan to contribute to the HSA each month, on a schedule. Same result — but without scrounging the cash for a last minute tax break.