It’s our experience that the health savings account (HSA) is one of the most underrated and underutilized tax saving vehicles available out there, and there are some unique HSA financial planning strategies that many people just don’t know about.
So what exactly is a Health Savings Account (HSA)?
A health savings account (HSA) is a tax-advantaged savings account for paying medical expenses available to those enrolled in a High Deductible Health Plan (HDHP). HSAs are owned by the individual, differentiating them from company-owned Health Reimbursement Arrangements (HRAs) that are an alternate tax-deductible source of funds paired with HDHPs. Unlike a Flexible Spending Account (FSA), HSA funds roll over and accumulate year over year if not spent and have the ability to earn tax-free growth on the account. HSA funds may be used to pay for qualified medical expenses at any time without federal tax liability.
What are the benefits of opening an HSA?
1. Tax-deductible: Contributions from employees and employers to the HSA are 100% deductible (up to the legal limit) — just like an IRA.
2. Tax-free: Withdrawals to pay qualified medical expenses, including dental and vision, are tax free even in retirement.
3. Tax-deferred: Interest and earnings accumulate tax-deferred, and if used to pay qualified medical expenses, are tax-free. This allows you flexibility on when to spend and when to save.
4. Unused money is yours: Unlike a flexible spending account (FSA), unused money in your HSA isn’t forfeited at the end of the year; it continues to grow tax-deferred.
How can you start saving?
HSA holders can choose to contribute up to $3,450 for an individual and $6,900 for a family in 2018 by the 4/15 tax deadline. If you’re over 55, you get to save an extra $1,000 which means $4,450 for an individual and $7,900 for a family – and these contributions are 100% tax deductible from gross income. Minimum annual deductibles are $1,350 for self-only coverage or $2,700 for family coverage, as well as annual out-of-pocket expenses (deductibles, copayments, and other amounts, but not premiums) cannot exceed $6,650 for self-only coverage and $13,300 for family coverage. You can get an HSA through your benefits provider at work or an independent provider like Saturna, MyHSA, or Lively.
What are some HSA financial planning strategies?
Some people are using HSAs as a stealth IRA by collecting receipts for medical expenses, but not taking distributions from the HSA until much later in life so that they can maximize the period of time for tax-free compounding. There’s no time limit on the lookback for qualified medical expenses, so good record-keeping goes a long way here.
If you’re over 65, you can roll HSA balances into a regular IRA, but at that point distributions from the IRA would be taxable and balances are subject to required minimum distributions (RMDs) after 70.5. On the other hand, there’s always the risk that Congress changes its mind on the HSAs, so some would advocate for using HSA balances sooner rather than later.
Some people may want to consider the impact of an HSA when they are evaluating their health insurance options. The benefit of the $6,900 deduction to a family may outweigh the additional annual costs of the HDHP, versus having no HSA deduction with the cheaper non-HDHP. The key is to work with your CPA to evaluate the true after-tax costs.
How should I choose an HSA?
If your company’s benefits provider doesn’t provide an HSA option, there are a host of providers online. You’ll want to make sure administration fees are low, and they have a wide selection of low fee investment options. Some providers require you to keep a minimum amount in a low yielding savings account before they invest your funds, so look for a low threshold. Also, don’t underestimate the value of evaluating the features of the HSA provider, such as an easy to use website/app or tools to store receipts.
Are there any other limitations on HSAs?
HSA distributions for non-qualified medical expenses are subject to a 20% penalty and are taxable. Also, combining an FSA and HSA is generally prohibited. You also can’t contribute to an HSA if you’re enrolled in Medicare.