Contributed by: Melissa Joy, CFP®
Medical costs are an unwelcomed reality in today’s day and age – they are expensive and often come at the worst times. A common question from clients is, “can I get a break on my taxes as I pay for medical expenses?” The answer is, "it depends." Here is some helpful information related to medical expenses and taxes.
Medical expenses may be deductible, but only if they’re eating up a large part of your adjustable gross income which is also known as AGI. Your expenses will need to exceed 10% of your AGI to be considered deductible. If you’re 65 years or older, you can deduct if your expenses exceed 7.5% of AGI. (NOTE: stay tuned as this lower threshold is currently set to expire in 2017.) When in doubt, you can find more information by visiting the IRS “Can I Deduct my Medical and Dental Expenses” tool.
Self-employed individuals may be able to receive a self-employed health insurance deduction.
Know your qualifying medical expenses
The IRS has a laundry list of eligible expenses including standard payments to physicians, pharmaceutical payments, etc. There are also more obscure qualifying expenses such as weight loss programs in some cases, medical equipment such as hearing aids or guide dogs, and costs of transportation for medical care. Other expenses that may seem to be medically related may not be deductible including cosmetic surgery, over-the-counter medicines, or funeral or burial costs.
Flexible Spending Accounts
If your employer offers a flexible spending arrangement, you can set aside money from your paychecks to go toward medical expenses. These funds are set aside before tax, so they’ll lower your tax bill in the current year. You can contribute up to $2,500 per year, but you need to know that you’ll have a similar amount of qualified expenses during the year, because in most cases, it’s “use it or lose it.”
Health Savings Accounts
If you are participating in a high deductible health plan, you may be eligible to contribute to a Health Savings Account or HSA’s. Health Savings Accounts allow you to set aside money in a tax-deferred account for future medical expenses. That account can grow or be invested over time for future use. My colleague Nick Defenthaler, CFP® breaks down the ins and outs of HSA’s here.
Early Withdrawals from IRA’s
If you are in the unfortunate position that you need to withdrawal from your IRA or qualified plan to pay for unreimbursed medical expenses, you may be able to avoid the 10% early withdrawal penalty. This also may be available in an IRA for health insurance premiums while unemployed. Keep in mind that an early withdrawal occurs before age 59 ½. This still means that the distribution will be taxable, and if it’s after age 59 ½, it would essentially be like any other distribution with no distinct tax advantages. We see early distributions as a last resort. Make sure to consider your options carefully before proceeding.
Tax Advantages from the Affordable Care Act
As I write this blog in March 2015, the Affordable Care Act is still in full effect although a case currently being considered at the US Supreme Court may change this. We have found that clients who have retired early or are between employment may qualify for Affordable Care Act subsidies, lightening the burden of the costs of health insurance. We have written on this topic here and here if this seems like it might be the right option for you.
This article is a brief summary which merely taps the surface of the intricate relationship between health care and taxes. One of the primary advantages of an ongoing relationship with your financial planner and tax professional is that they can understand your specific situation and advise according to current law to your advantage. If you have any questions, please don’t hesitate to contact me.
Melissa Joy, CFP® is Partner and Director of Investments at Center for Financial Planning, Inc. In 2013, Melissa was honored by Financial Advisor magazine in the Research All Star List for the third consecutive year. In addition to her contributions to Money Centered blogs, she writes investment updates at The Center and is regularly quoted in national media publications including The Chicago Tribune, Investment News, and Morningstar Advisor.
Financial Advisor magazine's inaugural Research All Star List is based on job function of the person evaluated, fund selections and evaluation process used, study of rejected fund examples, and evaluation of challenges faced in the job and actions taken to overcome those challenges. Evaluations are independently conducted by Financial Advisor Magazine.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Melissa Joy, CFP® and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. You should discuss any tax or legal matters with the appropriate professional. Be sure to contact a qualified professional regarding your particular situation before making any withdrawal decision.