Are Medical Premiums a Qualified Expense? Maybe.

You can reimburse tax-free some - but not all - medical premiums from a Health Savings Account.

A Health Savings Account represents a tax-efficient means of saving for future qualified medical expenses, whether you receive that care next month, next year, or in retirement. The list of qualified expenses includes certain premiums. A Health Savings Account balance may help you pay these premiums during periods of lower income, whether you are between jobs, starting your own small business, or retired and living on a lower, fixed income.

Let's review the many ways that a Health Savings Account can reduce the cost of coverage.

Pre-65 Medical Coverage

You can reimburse tax-free your premiums for medical coverage if you're collecting unemployment benefits or you continue your group coverage by exercising your COBRA rights.

Example: Juanita leaves her job and elects COBRA at a monthly $650 premium. She can pay that premium with pre-tax funds through withdrawals from her Health Savings Account.

You cannot, however, reimburse tax-free any other medical coverage from your Health Savings Account.

Example: Juanita (above) declines COBRA and instead purchases coverage through her state's marketplace. Because she's young, the premium - even without a subsidy - is lower than her COBRA premium. This premium is not a qualified expense. If she pays her premium through her Health Savings Account, she will include that amount in her taxable income and pay an additional 20% tax as a penalty for withdrawing funds for a non-qualified expense.

Premiums for other benefits like dental and vision coverage and voluntary plans (critical illness, hospital, and accident) are never qualified expenses, regardless of age.

Premiums for medical coverage for early retirees are not a qualified expense. If you retire early, look to COBRA (you can reimburse monthly premiums tax-free from your Health Savings Account) or coverage through a spouse's employer-sponsored plan (your spouse almost certainly pays her share of premiums tax-free through her company's Cafeteria Plan) to reduce the net cost of coverage. Or, with a low income, you may qualify for advance-premium tax credits (taxpayer-funded premium subsidies) in the nongroup market.

Long-term Care Insurance

You can reimburse tax-free, subject to annual limits imposed by the Internal Revenue Service, premiums that you pay for plans that cover your stay in a long-term care facility like a nursing home. These premiums are a qualified expense, regardless of your age when you pay the premiums.

A qualified long-term care plan must meet certain requirements (see Qualified Long-Term Care Services here). And the amount of premiums that can be reimbursed tax-free from a Health Savings Account (or deducted as a medical expense) ranges from $450 if you're age 40 or under to $5,640 if you're age 71 or older.

Most Americans don't buy long-term care insurance because premiums are high. Among those who make provisions for nursing-home expenses, most purchase hybrid policies that combine permanent life insurance with an option to access benefits to pay long-term care bills.

Thus, in practical terms, very few Health Savings Account owners experience the tax benefit of reimbursing long-term care premiums tax-free through their Health Savings Account. But it's an option for those who buy a qualified policy.

Medicare Premiums

Health Savings Accounts offer superior tax benefits to either tax-deferred or Roth retirement account. You contribute funds to a tax-deferred retirement account before federal or state income taxes are applied (when you fund it through your company's Cafeteria Plan) or you contribute personal funds and deduct the eligible amount on your personal income tax return. Withdrawals are always included in taxable income. You contribute post-tax dollars to a Roth account and, in exchange, most distributions aren't included in taxable income.

Health Savings Accounts trump both retirement accounts. Contributions aren't subject to federal income or payroll taxes, nor are state income taxes imposed (except for residents of California and New Jersey). Distributions for qualified expenses are never included in taxable income.

On which Medicare premiums can you spend your Health Savings Account balances without reporting the distribution as taxable income?

Part A premiums. Part A covers inpatient, home-health, and hospice services. Most Americans prepay their lifetime Part A premiums when they (or their spouse) earn a certain level of income for 40 quarters (10 years) of work. Anyone who fails to reach that threshold must pay monthly premiums, which are qualified for tax-free distribution from a Health Savings Account.

Part B premiums. This Part reimburses outpatient services like doctor visits, imaging, cancer treatments, and emergency care. You pay a monthly premium of at least $164.90. That amount rises with higher incomes. This premium is a qualified expense and can be reimbursed tax-free from your Health Savings Account. If you defer enrollment in Part B at age 65 and a penalty applies (it often doesn't), that penalty - in the form of a permanent monthly premium surcharge - also is a qualified expense.

Part B premiums are deducted from Social Security checks. If yours is, you can work with your Health Savings Account administrator to establish regular withdrawals to reimburse you for this expense.

Part D premiums. Part D covers prescription drugs. It's offered by private insurers. The premiums are a qualified expense, so you can reimburse them tax-free from your Health Savings Account. If you work past age 65 and are covered by an HSA-qualified plan, you may not have prescription-drug coverage as rich as Part D. In that case, you face a lifetime monthly premium surcharge, which is also qualified for tax-free distributions.

Part C premiums. Part C, also called Medicare Advantage, is a private alternative to traditional (Part A and Part B) Medicare. It's offered by private insurers and may nor may not include a premium (you pay your Part B premium and Medicare sends a monthly amount to the private insurer). If your plan includes a premium, that cost is a qualified expense.

Most people who enroll in traditional Medicare also purchase a Medicare Supplement plan, which reimburses certain out-of-pocket expenses and caps out-of-pocket financial responsibility. Premiums for these plans, which are often called Med Supp or Medex) are not qualified expenses. Therefore, any Health Savings Account withdrawals used to pay premiums are included in taxable income (without an additional penalty, which is waived when the owner turns age 65).

The Bottom Line

Unless you remain (or your spouse) remains continuously employed and you die before you enroll in Medicare, you will have to pay premiums for medical coverage without the benefit of an employer's Cafeteria Plan. That means that you won't enjoy the opportunity to pay your premiums with pre-tax dollars . . . unless you fund a Health Savings Account. This account allows you to reimburse certain premiums tax-free, thus reducing your net monthly cost of coverage. It's another reason to fund your account, even when receive few medical services, and to retain your balances even when you could reimburse a small, qualified expense tax-free.

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The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.