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The Lesser-Known Benefits of HSA’s

Health Savings Accounts (HSAs) are growing rapidly. Serious savers are embracing their immediate tax benefits and are learning of their even greater long-term value. The basics of HSAs are largely understood, namely, that they are coupled with a high deductible health plan (HDHP) and allow you or your employer to contribute pre-tax dollars which grow tax-deferred until withdrawn tax-free for qualified health care expenses. In this article, we seek to explore some of the lesser-known aspects of HSAs.

Ways to use HSAs

The first way to use an HSA is as a pass-through account which allows you to deduct 100% of your health-related costs. Dollars flow in to the account, and flow out throughout the year to cover current medical expenses. The account value doesn’t build.

The second way to use an HSA is to take advantage of the triple tax benefit – contributions are tax deductible, the assets grow tax deferred, and withdrawals are tax free if used for qualified medical expenses. In this case, tax deductible dollars are contributed to the HSA, and no (or few) expenses are paid from it. You may be extra healthy, or you may pay your expenses with dollars outside the HSA. Year after year the account value builds; there is no “use it or lose it” penalty with HSAs. Why do it this way? Either you have the cash flow to pay your medical expenses (or you are healthy) and you are serious about saving for your future health needs in a tax-advantaged manner.

What to Consider

  • You are eligible to contribute to an HSA if you have a HDHP. The IRS defines HDHP each year (https://www.healthcare.gov/glossary/high-deductible-health-plan/).
  • Each year you are eligible, you can make a tax deductible contribution. In 2022, if you have an individual plan, you can contribute $3,650 and a family can contribute $7,300. If you are over 55, you can add $1,000 more. For 2021, the amounts were $3,600 and $7,200.
  • You have until the April tax deadline of the year following the tax year to make the contribution. This gives you extra time to figure what you can contribute and to locate the money to do so.
  • If your employer is contributing to your HSA, but not reaching the maximum allowed, you can top up your contribution. You’ll get the deduction on your taxes.
  • If you have a child who is working and is covered by an HSA, you might want to encourage them to start an HSA and help them to “top up” the contribution.
  • If you have a child who is covered by your HDHP but not claimed as a dependent on your tax return, they can also open an HSA in their name.
  • You can’t deduct a health expense from an HSA which was incurred before the HSA was established. As a result, you may want to set up your HSA sooner and before a health incident occurs.
  • If you change to a HDHP at any time up to December 1st of that tax year, you can still contribute the full amount to your HSA for that year.
  • HSA contributions are not only excluded from income tax but are also excluded from FICA payroll taxes, unlike pre-tax 401(k) contributions which are subject to FICA payroll taxes.

Should an HSA Balance Be Invested?

The landscape of HSA custodians has changed materially for the better since the creation of HSA’s in 2003. There are more players in this market which has led to more competition on fees and more investment options. In addition to bank account options, several HSA custodians offer low-cost investment choices. Fees are still typically higher than for IRAs, but this may also change as competition heats up. If your employer is contributing to your HSA, you may need to use the one they designate, but you can rollover balances periodically to a custodian of your choosing which may save on fees.

This brings us to the next question: Should you take risk with the money in your HSA? The answer “it all depends” is not helpful, but very true in this case.

If you are treating it as a transactional “in and out” account, it is not a good idea. But, if you have a 5, 10, 20-year time horizon, then you should invest. A good idea is to keep the equivalent of your annual deductible in a bank account and invest the rest. Don’t invest 100% in stocks, rather, look for a balanced mix of stocks and bonds. Health care costs continue to rise, so it is important that you invest to maintain purchasing power.

HSA Withdrawals: the Secret to the Sauce

  • Even if you are no longer eligible to contribute to an HSA, you and your family (spouse and dependents) can use the HSA to pay for qualified expenses.
  • Qualified medical expenses include things that may not be covered by your health plan–namely deductibles, co-insurance, dental bills, eyeglasses, eye exams, home improvements for medical reasons, acupuncture, to name a few.
  • You generally cannot use the HSA to pay health insurance premiums EXCEPT for:

-Long-term care (LTC) premiums
-COBRA health coverage
-Health care insurance while unemployed
-Medicare premiums for Part A, B and D. (but not Medigap coverage)
-Medicare HMO premiums

  • You can deduct expenses which you incurred in prior years (but after HSA was established).

These rules make the HSA an interesting strategy for saving for future medical costs. There’s a strong argument to be made for contributing to an HSA even before you max out your 401(k)- though we recommend maxing both out.

Now that you are getting the hang of this, let’s think about the implications of the withdrawal rules. You can keep records of your unreimbursed medical costs for years after you first start your HSA and if the time comes and you need some extra cash, you can make a tax-free withdrawal. If you fear you are behind in your retirement savings, this is a way to boost savings in a tax-deferred, tax-free vehicle, and at the same time, keep your options open! In retirement you can use the HSA for Medicare premiums, LTC premiums, as well as costs not covered by Medicare. It doesn’t get better than that.

Nothing comes without a few caveats, and this is no exception. Be careful that you keep good records. You can’t deduct the expenses AND use them for justification of an HSA withdrawal. That’s double dipping. Also beware that when you are Medicare age (65), you may not be eligible to contribute to an HSA any longer , if you enroll in Medicare Part A. Proceed with caution as you approach 65.

As the HSA landscape has matured, health savings accounts have become a very effective saving vehicle for medical expenses in retirement. If you can contribute to an HSA and let the balance grow, you will be rewarded with triple tax-free withdrawals later.

 

References:

https://www.irs.gov/uac/about-publication-502  IRS Publication 502, Medical and Dental Expenses

https://www.irs.gov/pub/irs-pdf/p969.pdf   IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans

http://www.investmentnews.com/article/20170209/FREE/170209892/medicare-enrollment-ends-hsa-eligibility  Medicare enrollment ends HSA eligibility, Investment News

https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/irs-2022-hsa-contribution-limits.aspx

Robin Sherwood, CFP®

With over twenty years of experience, Robin assists clients in maximizing their financial well-being. She counsels clients in the areas of retirement, taxes, investments and estate planning.

Robin is a CERTIFIED FINANCIAL PLANNER™ practitioner and a registered member of NAPFA. She has an MBA in Finance from the Wharton School at the University of Pennsylvania, and a BA from Colby College.
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