Health savings accounts (HSAs) are a much better financial tool than most people realize and are capable of substantially improving your total financial position.
So what are they, and how do they work? HSAs are like the 401(k)s of healthcare—they provide you with a tax-advantaged way to save (and invest) for medical expenses long-term and are especially beneficial for retirement savings.
HSAs Are Super Special
Health savings accounts are tax-advantaged vehicles to save for health and medical care, but they do so uniquely.
Unlike tax-deferred or Roth retirement accounts, HSAs offer not 1, or even 2, but 3 tax benefits! Think of HSAs as triple-tax-free.
How do they do that?
- Pre-tax contributions—You can deduct your contributions to an HSA just like a 401k or IRA.
- Tax-free growth—Earnings grow tax-free on investments you purchase inside the account.
- Tax-free distributions—When you withdraw money for qualified medical expenses (medical, dental, vision, medication, etc.), you still don’t incur a tax liability. The definition of “qualified medical expenses” is rather broad, like premiums, prescriptions, and other healthcare, dental, or vision needs. Check with your plan to see what is and isn’t covered.
So what happens if you use HSA money for non-qualified expenses? You would have to pay income tax on the distribution, and the IRS tops it off with a 20% penalty (until you turn 65). Not great!
A bonus is that your HSA balance rolls over every year, making it excellent for long-term saving. Plus, you can elect to invest the funds in your HSA. While few are doing this, it’s an excellent tool to create wealth. Over time, you can build up quite a balance in much the same way you build your IRA!
There are annual contribution limits. For 2022, the limit for a self-only plan is $3,650 and $7,300 for a family.
How Can You Qualify for An HSA?
The most considerable hurdle to overcome with an HSA is simply qualifying for it. The number one determining factor is that you must be enrolled in a high-deductible health plan (HDHP).
For 2022, to qualify as an HDHP, you must have a minimum deductible of $1,400 if you are the only person covered by the plan or $2,800 if your family is covered. The IRS also sets out-of-pocket maximums for HDHPs. Those limits are $7,050 for self-only coverage and $14,100 for family coverage this year.
If you have a low deductible plan, you can’t contribute to an HSA.
Don’t let the “high deductible” or “out of pocket maximums” scare you. In most cases, a higher deductible also means lower premiums. Insurance companies recognize that their exposure to claims expenses is lower when the insured has accepted a higher deductible. In a scenario of a large medical expense, lower premiums and higher out-of-pocket costs largely offset each other. In a scenario that does not include a large medical bill, the lower premiums are yours to keep!
HDHPs work for many people. In most cases, it won’t take you long to save up enough money in your HSA to cover the deductible, and your money will grow until you need it, which is the whole point.
Another critical point is that you can’t contribute to an HSA if enrolled in Medicare. However, you can still use an existing HSA! So if you’re in retirement, you can make tax-free withdrawals for medical expenses—the time when they’ll likely be at their highest.
Make Your HSA Dollars Stretch Farther By Investing Them
Remember, you can invest the money in your HSA. And if you plan to keep the money in the account long-term, you should!
91% of people who own this account don’t realize that! That means they are potentially missing out on a huge opportunity.
Unfortunately, a lot of people treat HSAs like a piggy bank—just a temporary place to park cash. But investing the money makes it another avenue for retirement saving.
Think about your HSA in the long term. When you’re 60, would you rather use your tax-free HSA to pay for surgery or your taxable brokerage account/IRA? If you use your brokerage account or IRA, you’d have to pay tax on the distribution, but with your HSA, those dollars would be tax-free.
The tax-free component is significant because being able to withdraw money this way can significantly extend the life of your retirement accounts.
How HSAs Can Help You In Retirement
HSAs can bring so much value to your life in the form of financial savings.
To fully maximize that value, try contributing the full amount each year and investing your contributions.
Try not to touch it unless you have extraordinarily high medical expenses. You really can’t have too much in your HSA, so don’t be afraid to let it grow.
At this stage, you might be asking the following questions:
1. If I funded an HSA and I have regular or even unexpected medical expenses, why wouldn’t I use the HSA to cover those expenses? Isn’t that the whole purpose of the account?
Answer: Like 99.99% of personal finance questions, the appropriate response starts with “well, it depends”....
To take advantage of current year medical expenses in a tax-advantaged way, a Flexible Spending Account or FSA is an appropriate vehicle to accomplish this. An HSA is designed to help you save for and eventually pay for future medical expenses. The HSA offers both the ability to rollover the balance year after year and the ability to invest the funds in the meantime. Neither of these features are available in an FSA. Unless the large medical bill will create a financial hardship if you pay it with other funds, you’re better off paying the bill from your taxable account and keeping the HSA balance growing tax-deferred.
2. What happens if I don’t have large medical bills in the future and I have a large HSA balance?
My first reaction to this scenario is……congratulations! Think about that for a moment. You are well into your retirement and you have no tangible medical issues. Who wouldn’t take that outcome? As for the large HSA balance, here’s how you would resolve that “problem”:
You keep copies of all of the medical expenses that you have incurred since you opened the HSA. If the HSA was opened in 2022, and it’s now 2042, you can submit expenses that you incurred any time between 2022 and 2042. Said differently, the expense and the reimbursement do not have to be in the same year. As long as the expense is dated after the opening of the HSA, it is eligible for reimbursement. So, you saved and invested diligently for the possibility of large medical bills and now you have a large balance that can be distributed TAX-FREE for your trip to Spain, or for gifts to your grandchildren, or for any reason.
In the extreme case where you have no tangible medical expenses over your entire lifespan and you have a large HSA balance, you wait until age 65 to avoid the 20% penalty and take taxable distributions, exactly the same as with your 401k/IRA. You still enjoyed a reduction in taxes in the year of contributions and tax-deferred growth for decades.
Medical care in retirement is so expensive. Even factoring in Medicare coverage, you’ll need the help.
A Fidelity study estimates that a healthy couple will spend roughly $300,000 in after-tax dollars on healthcare throughout retirement. And that’s in today’s dollars; imagine how much higher that number will be when it comes time for you to retire.
HSAs As Part of Your Comprehensive Investment Plan
HSAs are a great addition to your portfolio because of the immense tax advantages,
No other account type provides you with an immediate tax deduction and allows earnings to grow tax-free.
If you aren’t already taking full advantage of the benefits HSAs provide and want to get started (or aren’t sure if you qualify), call me today, and we will get started developing your approach to HSAs.