The Tax Advantages of an HSA for Expats

The Tax Advantages of an HSA for Expats
Updated on April 9, 2024

Moving to another country to work as an American expat can be exciting, especially if you’re young. You can explore exotic cuisines and engage in novel experiences. However, it would be best if you tied up any loose ends specific to the US, including anything tax-related. Below are the tax advantages of an HSA for expats.

Should You Keep Your HSA as an Expat?

The quick answer is yes. There is no reason to close your HSA account because you’re moving abroad.

Some expats make that mistake. They take the tax hit (income tax and penalty for those under 65) to have the funds on hand. However, the HSA is your safety net when things go south. You can access it in a pinch for medical and other expenses in another country.

Leaving it to grow makes the most sense if you’re a young expat, especially when your provider offers investment options. They can contribute significantly to your retirement funds. Once you hit 65, you can withdraw HSA funds for any reason without penalty. However, you still pay income taxes if you don’t use them for allowable medical expenses.

What is an HSA?

An HSA is a pre-tax savings account specific to medical expenses. You can contribute as much as $3,850 for individuals and $7,750 for family coverage in 2023 to your HSA annually. If you are over 55 but not more than 65, you can add $1,000 to the maximum contribution.

You can add money to your HSA pre-tax, which means you save money on taxes. The money in your HSA grows, and you can take out funds without incurring a tax penalty to pay for qualified medical expenses. Additionally, you can roll over HSA funds until age 65.

You can use the money in your HSA for the following:

  • Doctor visits
  • Prescription drugs
  • Eyeglasses and contacts
  • Dental care
  • Mental health care
  • Long-term care

You can also use your HSA to pay for online purchases on Amazon, such as prescription drugs. HSAs are a great way to save money on taxes and save for future medical expenses. If you have an HDHP, you should consider opening an HSA.

You can set up an HSA through any IRS-approved trustee, such as a bank, insurance company, or brokerage firm. Ensure you choose an HSA provider to give you the most bang for your buck.

Here are some things you should know about HSAs:

  • You cannot open an HSA if enrolled in Medicare, a health maintenance organization (HMO), or a preferred provider organization (PPO).
  • You can make HSA contributions through payroll deduction or lump-sum contributions.
  • You can withdraw money from your HSA at any time. However, you must pay taxes on the withdrawal if you use it for non-medical expenses.
  • You can carry over any unused money in your HSA yearly.
  • You can use HSA funds to pay for your HDHP deductible, copayments, and coinsurance. However, you cannot use it to pay for your premiums.
  • The bank typically sends you a debit card after signing up for an HSA. You can use it to pay for allowable expenses.

Can You Contribute to an HSA as an Expat?

All US citizens can open an HSA and contribute to it, provided they have a qualifying high-deductible health plan (HDHP). An HDHP has a lower premium than traditional health plans but higher out-of-pocket costs, often totaling four figures. The minimum HDHP deductible in 2023 is $1,500 for self-only and $3,000 for family coverage.

An HDHP is appropriate for people with low medical costs as it safeguards against catastrophic medical events while offering low premiums. Plus, since the monthly premium is lower, you can save for future medical expenses using a HSA.

An expat can continue contributing to an HSA if they continue paying for an HDHP. However, the money they save from tax-free HSA may be less than the premiums they pay for an HDHP. The average cost of an HDHP was $928 in 2022.

Expats may not contribute to their HSAs if they maintain only a foreign health insurance policy. The good news is you can still use HSA funds for qualified medical expenses outside the US.

Can You Use HSA Funds While Abroad?

You might think your HSA is useless as an expat. However, nothing in the tax laws prohibits you from using the funds abroad to pay for medical treatment. It is an excellent way to get tax-free money for your healthcare costs.

Even if an expat is no longer eligible to contribute to their HSA, they can still use the funds in the account to pay for qualified medical expenses. This access can be a valuable way to save money on healthcare costs for expats who live in countries with high healthcare costs.

You can use it for medical transport and even lodging for a companion when getting medical care. Prescription and OTC medications are also eligible if they are legal in the US and the host country. Similar requirements also apply to medically necessary services. Additionally, you must consume purchased medications in the host country.

The HSA is not a health insurance plan, so that you can use it anywhere. Suppose the debit card linked to your HSA has a Visa or Mastercard symbol. You can use it to pay for medical expenses directly, provided the vendor accepts Visa or Mastercard. However, most providers will charge a conversion fee between one and three percent when using your HSA-linked debit card. The conversion rate might also be unfavorable.

Suppose you didn’t get a debit card from your bank or broker, or the vendor does not accept Visa or Mastercard. In those scenarios, you must pay the expense first and get reimbursement from your HSA provider. You will probably need to provide copies of the medical bill, receipt, prescription, or doctor’s letter.

What Are the Tax Advantages of an HSA?

The tax advantages of an HSA for expats include tax-free contributions and reduced taxable income, earnings, and distributions. Contributions made to HSAs are usually tax deductible, but most expats cannot make any contributions without being penalized.

Tax-free Contributions

Contributions are deductible if you are allowed to contribute to an HSA plan. This reduces your current year’s tax bill based on the tax bracket or marginal tax rate you are in. For example, if you contribute $1,000 and are in the 22% tax bracket, you ultimately end up paying $220 less. If you are in the 35% tax bracket, you would pay $350 less.

You must have an HDHP health insurance plan to make deductible contributions. Few US-based health insurance plans, if any, provide overseas coverage. Therefore, most expats choose a health insurance plan in their host country and not an HDHP plan. However, some expats may keep an HDHP plan to get treatment in the US under a health insurance plan. 

Tax-free Earnings

The money you put into an  HSA is invested. All the investment earnings are not taxed as long as you use funds in an HSA for qualified medical expenses. The earnings compound over the years could lead to the balance in your account growing significantly.  

Tax-free Distributions

With tax-advantaged accounts such as a traditional 401 (k), you pay taxes on whatever you withdraw. That is not the case with HSA funds when you withdraw funds to pay for qualified expenses.

Potential Penalties for HSA Contributions without an HDHP

If you contribute to an HSA without a qualifying High Deductible Health Plan (HDHP), you’ll face two types of penalties. First, a flat 6% annual penalty applies to excess contributions until they are removed—this is not a cumulative fee. 

For example, if you made an excess contribution of $1,000 to your HSA and left it uncorrected, you would incur a 6% penalty ($60) for the first year. If the excess remains in the account for a second year, another 6% penalty would be assessed for that year. This 6% penalty would continue to be assessed annually for each year the excess contribution remains in the account. It’s not a cumulative penalty; instead, a 6% penalty is applied each year until the excess is corrected.

The second penalty is a 10 percent early withdrawal penalty on any investment income that excess contributions earned. In addition, the entire investment income is considered taxable income. It is subject to tax along with all your other income. 

For example, you made a $1,000 excess contribution each year for five years. From those contributions, you had a total investment income of $2,000. Suppose you are in the 22 percent tax bracket. Your 10% early withdrawal penalty would be $200. You would also owe income tax of $2,000 multiplied by 22 percent, or $440. The penalty on $5,000 of contributions would cost $640 in addition to the excess contribution penalty. 

When Should You Use Your HSA?

You can roll over your HSA until you turn 65, allowing your money to grow tax-free. If you use the funds, the interest will be less. It might be advantageous to reserve those funds for when it makes financial sense to use them.

For example, your doctor prescribes antibiotics that you can easily cover. Don’t use your HSA for that. On the other hand, you need surgery, and you don’t have enough cash to pay for it. Use your HSA funds to cover the gap instead of putting it on your credit card. The interest charges will likely be more than anything you would have earned by keeping your HSA funds intact.

When Should You Not Use Your HSA as an Expat?

An HSA helps pay for qualified medical expenses, but you might not need it as an expat. Many expats acquire resident status in their work country, making them eligible for universal healthcare. If your medical costs are minimal due to this arrangement, you might not need to use your HSA funds.

You may also want to refrain from using your HSA if you can’t prove your expenses are legally prescribed or qualified. That means you may have to pay taxes plus penalties for the distribution. If you’re not sure, consult your provider about it.

The IRS tax code is 7,000 pages. Want the cliff notes version for expats? Let us help.