Perhaps you’ve heard of an HSA, or Health Savings Account, but you’re not quite sure how they work or if they’re even a good fit for you. There are many reasons to consider a Health Savings Account, but first, let’s explore what an HSA is.
A Health Savings Account is a tool that allows you to deduct money from your paycheck and make contributions, pre-tax, and divert it into an account to be used for medical expenses. This reduces your taxable income and allows you to use the funds tax-free for qualified medical expenses that aren’t covered by health insurance. You can use the money to cover your deductible, co-pays, prescription drugs, or many other expenses that would typically come out of your pocket with after-tax money. Keep in mind that the expense must be a “qualified” medical expense, so if this criteria isn’t met and the expense is non-qualified, you will be taxed at your normal income tax rate plus 20% if you’re under 65.
To qualify for an HSA, you must be enrolled in a High Deductible Health Plan (HDHP). Each year, you have the option of deciding how you would like to contribute to you HSA account without exceeding the government-mandated maximum. For 2017, you are allowed to contribute $3,400 as single, non-family insurance coverage, or $6,750 as a family. Those over 55 are eligible to contribute up to $1,000 more as an Additional Catch-Up Contribution.
In 2016, it’s estimated that there are $32 billion in HSAs and less than 20% of it is invested for growth. People aren’t aware of the investment tools they can use to generate more money. Although people think of it as a bank account for medical costs, many sophisticated investors treat this as a “secret IRA” or “medical IRA” and invest their HSA balances for long term growth as you would in your 401(k), IRAs, or other investment vehicles.
How can I Benefit from this?
There are great benefits to participating in an HSA. Not surprisingly, many of those benefits revolve around saving for, and paying for, health care expenses not covered by insurance. Yet there are other, lesser known ways, that an HSA can play a critical role in your overall portfolio. Examining the process below will help outline how:
- Money Goes in Pre-Tax: The contributions are made before your income is taxed, thus reducing your overall taxable income. Let’s say you’re an individual in the 25% tax bracket, and you contribute the full $3,400 annually. Your net impact to your take-home pay isn’t $3,400, it’s much less because the money was taken from your check pre Federal, State, and FICA1 (Social Security and Medicare) taxes, provided you use the money for qualified medical expenses.
- Money Is Withdrawn Tax-Free for Qualified Medical Expenses: Not only have you set aside the money pre-tax, you’re also withdrawing it tax free, as long as you’re using it for qualified medical expenses which includes most services provided by licensed health providers, as well as diagnostic devices and prescriptions. This isn’t just seeing the doctor. It can be all sorts of things you may not think of – premiums for COBRA, long term care and in-home care, hearing aids, cataracts, contacts, crutches, etc. Although you don’t have to show receipts to your tax preparer to document these expenses, be sure to keep them on file with your tax records.
- Money Rolls Over from Year to Year: Unlike other savings plans and cafeteria accounts (think Flex Savings Accounts [FSAs]), you do not have to use all of the money in your account each year. The funds in your account roll over automatically and remain indefinitely until used. There are no required minimum distributions. You don’t lose the money left in you HSA or the interest it’s earned. It’s your money.
- Money Grows Tax Free: Any interest earned in your HSA is not taxable. Because it isn’t a traditional investment or savings account, you will not incur a tax. Combine this with pre-tax deposits, tax-free withdrawals, no limits on rolling over funds from year to year, and perhaps you’re beginning to see how (and why) an HSA could be an important part of your portfolio! There is no other savings tool that allows this flexibility and these tax advantages.
Although HSAs have been around for over a decade, many advisors aren’t talking to their clients about them, but they should be. An HSA is a versatile tool that can cover medical costs and assist with retirement savings. Think about it: If you’re fortunate enough to remain relatively healthy, and don’t require extensive care for many years, you could build a significant balance in your HSA. Any funds not used for medical expenses can be withdrawn after age 65 (or Medicare eligibility) with no penalty. At that time, you would simply be required to pay income tax on the funds just as you would with any traditional IRA distribution. It can be a very worthwhile way to supplement your traditional retirement savings.
Have you considered adding an HSA to your financial plan? We can help you determine what role it may play for your specific situation, whether it means you’re exclusively using the funds for medical expenses, thus reducing your overall out-of-pocket, or creating a strategy to let the money grow tax-free until retirement. Our goal is to educate clients and help you make wise decisions as we build your financial strategy. An HSA may just be one of the pieces to help you on your path to accomplishment.
And, don’t think it’s too late to start or max your 2016 HSA contribution! If you qualify for an HSA, you can make a 2016 contribution up until the tax deadline of Tuesday, April 18th, 2017.
1 The inclusion or exclusion of FICA depends upon if contributions are made through payroll.