Why You Need a Health Savings Account
Our experience at Planning to Wealth is 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)?
Established by the Medicare Prescription Drug Improvement and Modernization Act of 2003 and available since 2004, HSAs have been increasingly popular over the last few years. A Health Savings Account (HSA) is a tax-advantaged savings account for paying medical expenses available people enrolled in a High Deductible Health Plan (HDHP). HSAs are owned by the individual, and unlike a Flexible Spending Account (FSA), HSA funds roll over and accumulate year over year if not spent. This allows the funds to grow tax-free over time. HSA funds may be used to pay for qualified medical expenses at any time without federal tax liability. “I don’t believe many taxpayers with a HDHP are aware of the triple tax advantages offered by HSA investment options, and unlike an FSA, there is no use-it-or-lose-it requirement with an HSA,” says New York City-based tax expert Sherwood Aristide, CPA.
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 a 401K.
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?
Maximizing Compounding. 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.
Funding Retirement with an HSA. 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.
Evaluating Health Insurance Plans. While choosing the right health care plan for your family should be the main priority, and you wouldn't want to take an inferior health plan just to save money on taxes, 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.
Rolling an IRA into an HSA. The IRS allows you to do a one-time rollover of IRA money into an HSA up to the annual limits. This could be a great strategy if you have an upcoming large medical expense, but don't have the cash to fund the account. Following the rules on this strategy is imperative, so it's best to coordinate this with your CPA. The funds will have to go directly from the IRA to the HSA, and you have to still be enrolled in a HDHP.
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 or if you're claimed as a dependent on someone else's tax return.
While the HSA's triple tax benefits make them attractive for many families, an HSA shouldn't be your only savings vehicle. Most families need an appropriately sized emergency fund to cover unforeseen expenses. As well, the HSA contribution limits aren't high enough to fully fund retirement for most families, and HSAs aren't good accounts to save for buying a home or for your children's college education. To see the benefits for an HSA for yourself, estimate your tax savings using this HSA Tax Savings Calculator from HSACenter.com.
David Flores Wilson, CFP®, CFA, CDFA®, CCFC is a New York City-based CERTIFIED FINANCIAL PLANNER™ Practitioner & Wealth Advisor at Watts Capital. He can be reached at firstname.lastname@example.org.