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.

Health Savings Accounts (HSAs) Explained

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.

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 401(k).

2. Tax-free: Withdrawals to pay qualified medical expenses, including dental, Medicare premiums, long-term care premiums, care-giving costs 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, even if you change jobs.

Contributing to an HSA

HSA holders can choose to contribute up to $3,500 for an individual and $7,000 for a family in 2019, and $3,550 for an individual and $7,100 in 2020 by the 4/15 tax deadline. If you’re over 55, you get to save an extra $1,000, and these contributions are 100% tax deductible from gross income. Unlike most tax saving vehicles, there’s no income limitations for contributing. Moreover, you don’t need earned income or compensation to qualify for a contribution, which is a requirement for IRAs and Roth IRAs.

Minimum annual deductibles in 2019 are $1,350 for self-only coverage or $2,700 for family coverage, but those go up to $1,400 for an individual and $2,800 for a family in 2020. Annual out-of-pocket expenses (deductibles, copayments, and other amounts, but not premiums) cannot exceed $6,750 for self-only coverage and $13,500 for family coverage in 2019 and $6,900 and $13,800 in 2020.  

You can get an HSA through your benefits provider at work or an independent provider like Saturna, MyHSA, or Lively. As well, contributions can come from different sources aside from yourself, including a relative or your employer.

HSA Financial Planning Strategies and Tips

• 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 look back for qualified medical expenses, so good record keeping goes a long way here. Some people don’t realize they have investment options and leave their funds in cash balances. This is a mistake as people should be investing their funds to maximize compounding. Given the long-term horizon on this strategy, it may make sense to invest the HSA aggressively.

• Funding Retirement with an HSA. If you’re over 65, you can roll HSA balances into a regular IRA and spend the funds on non-qualified health expenses without a penalty. However, if you do so distributions from the IRA would be taxable and balances are subject to required minimum distributions (RMDs) after 70.5. There’s always the risk that Congress changes its mind on the tax-free distribution features of HSAs, so some would advocate for using HSA balances sooner rather than later.

• HSAs and Social Security Income. If you use your HSA in retirement for only qualified medical expenses and don’t roll it into an IRA, you could benefit by having fewer of your Social Security benefit dollars taxed in retirement. Up to 85% of Social Security benefits can be taxed for couples with provisional income over $44,000 in retirement. RMDs from large IRAs can push many people over these thresholds, so you can help minimize this by saving more in your HSA rather than in your IRA or 401(k).

• 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 deductible costs of the HDHP, versus having no HSA deduction with the higher premiums and lower deductible costs of a non-HDHP. In general, HDHPs work out best for health families. The key is to work with your CPA to evaluate each of these variables and determine the true after-tax costs. 

• Rolling an IRA into an HSA. The IRS allows you to do a one-time rollover of IRA or Inherited IRA money into an HSA up to the annual limits. This qualified HSA funding distribution (QHFD) could be a great strategy if you have an upcoming large medical expense, but don't have the cash to fund the account. This essentially is a way to convert money that will one be taxed until money that can sidestep taxes completely. Moreover, the distribution avoids the under 59.5 10% penalty. You can only do this once in your life though.

  Following the rules on this strategy is imperative, so it's best to coordinate this with your CPA and HSA provider. The funds will have to go directly from the IRA to the HSA and not as an IRA rollover. As well, you have to still be enrolled in a HDHP all year to do a QHFD. If you are about to enroll in Medicare or claim Social Security, for example, you should probably avoid this strategy. Keep in mind that if you do effect a QHFD up to the annual limit, you can’t make an additional HSA contribution amount.

HSA Options in the Market

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.

HSA Limitations

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. You can continue to contribute to an HSA after age 65 if you delay enrolling in Medicare by continuing to work and not taking Social Security. As well, you don’t need to be on a HDHP to take distributions.

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. 

Actual benefits of HSAs in Dollars

To calculate the tax benefit of an HSA contribution over one year, check out the HSA Tax Savings Calculator from HSACenter.com. To see the benefit over time, we calculated how much would be in an HSA versus a regular taxable brokerage account if you maxed out an HSA every year for the next 30 years versus putting the same amount in a regular taxable account. We assumed a 3% inflation rate, a 6% return, a 75%/25% stock/bond allocation, stock turnover of 20% per year, 24% ordinary income rates, and 15% capital gains rates. After 30 years, the HSA would have $762,000, while a taxable account would have $698,000.

The difference of $64,000 would just be the benefit of tax-free compounding and tax-free distributions. We calculated the compounded benefit of the deduction from the HSA contributions to be another $178,000 after 30 years. You could get a total benefit of $242,000 from maxing out your HSA, and if you’re marginal tax rate is over 24% this benefit would be higher.

HSAs and Estate Planning

If you’re going to use HSAs as a long-term strategy, you should probably consider the estate planning aspects of them and choose your HSA’s beneficiary designations wisely. An HSA inherited by a spouse continues to remain an HSA for the surviving spouse, so he or she can continue to take tax-free distributions for qualified medical expenses. However, the full balance of an HSA inherited by a non-spouse is subject to income tax. If you are going to make a non-spouse the beneficiary, then one strategy would be to make the beneficiary someone in a very low tax bracket. You should avoid designating a minor as a beneficiary, given the administrative expenses that might be incurred by doing so. Giving your HSA to a minor is probably best done through a trust.

As well, if you don’t fill out the beneficiary designations, the HSA assets will be subject to the added time, expense and aggravation of probate. While many people place assets in a revocable living trust as part of their estate plan, you can’t do this with an HSA. You can however make the living trust a beneficiary of the HSA. One drawback to HSAs is that they have less asset protection than IRAs. HSAs aren’t protected during bankruptcy at the Federal level. Some states do protect HSAs in a bankruptcy, but most don’t.

David Flores Wilson, CFP®, CFA, CDFA®, CCFC is a New York City-based CERTIFIED FINANCIAL PLANNER™ Practitioner & Managing Partner at Sincerus Advisory. Click here to schedule a time to speak with us.