How Can I Benefit from a Health Savings Account?

What is a Health Savings Account?

As the public becomes more aware of tax-advantaged account types such as IRAs, Roth IRAs, and 529 college savings plans, there is another acronym that shouldn’t be overlooked – an HSA (Health Savings Account). An HSA is a tax-favored account created to pay medical expenses of the owner or their spouse and beneficiaries. For those eligible to participate in an HSA, the tax benefits can be substantial over time.

How does it work?

Contributions to the HSA are pre-tax (if saving through an employer), or tax-deductible if saved outside of a workplace plan. The funds inside the HSA can be invested for growth, if desired. The HSA can then be used to pay for “qualified” medical expenses, tax-free. Qualified medical expenses are determined by the IRS but includes most regular medical care, dental care, and prescription medicine, among others.

Who can participate in an HSA?

You must be covered by a high deductible health plan (HDHP) in order to contribute to an HSA. In 2021, the deductible for individuals must be at least $1,400, or $2,800 for families. If your plan has a lower deductible, you are not eligible to contribute to an HSA. However, you can still use funds in an HSA that you already have, if you still have money in an HSA from previous years.

Some employers who offer HDHPs will offer an HSA as an employee benefit, with the ability to save as a payroll deduction. However, even if your workplace does not offer an HSA, you are still eligible if you are enrolled in a HDHP. Many banks, credit unions, and investment companies offer HSAs to individuals.

What are the tax benefits?

Although medical expenses may be tax-deductible, it depends on the family; most find that they are unable to take the medical expense deduction. It requires an individual or family to itemize their deductions, and many find that the standard deduction is higher. In addition, the medical expense deduction is only available for expenses that exceed a certain level of income (currently, the deduction is available for expenses that exceed 7.5% of one’s gross income). Unless an individual or family experience unusually high medical bills in one year, these limitations typically prevent them from fully deducting medical expenses.

However, through an HSA, all qualified medical expenses can be paid on a pre-tax basis. Because the account is funded by pre-tax dollars, and qualified expenses are paid tax-free, this allows individuals to pay medical expenses with untaxed money – even if they take the standard deduction. Additionally, if the account was invested, all growth can be used for medical expenses without paying capital gains or other investment taxes.

Note – there is typically a tax penalty if HSA funds are NOT used for qualified medical expenses. For those under age 65, any non-qualified withdrawals incur regular income taxes as well as a 20% penalty. For those 65 or older, non-qualified HSA withdrawals are included in their income, but do not incur an additional penalty.

How much can I save into an HSA?

The IRS places contribution limits on HSAs. In 2021, the limit is $3,600 for individuals, or $7,200 for families with an additional $1000 catch-up limit for individuals 55 or older.

How does an HSA grow over time?

Unlike some plans (such as an FSA), the value in an HSA is not forfeited at the end of the year. The account belongs to you, and can be carried forward and even from employer to employer. If you’ve chosen to invest the money in the account, the growth is added to the account balance. Some individuals choose to contribute just enough to pay all medical expenses for the year, and so don’t carry large account balances. However, others choose to save and invest some of the funds for long-term growth. Although you can no longer contribute to an HSA once you participate in Medicare (typically age 65), you can continue to use any remaining HSA balance in retirement for healthcare expenses (which is typically when healthcare costs are highest).

Sounds great! Is it right for me?

For individuals who are already participating in a HDHP, you may consider adding HSA savings if they fall within your budget. Our health typically declines as we age, so even if you don’t have high medical expenses today, it may be beneficial to save for future expenses – especially if there’s a time that you’re no longer eligible for HSA savings (when you’ve moved to a lower deductible health plan, for instance, or in retirement and on Medicare). Unlike retirement accounts, in which you choose to pay taxes either now or later, an HSA used for medical expenses is never taxed – making it one of the most tax-favorable accounts available.

If you’re not currently enrolled in a HDHP, you are not currently eligible for HSA savings – however, you might be in the future if your health insurance plan changes. When examining health plans, the individual’s health, and that of their family, are important factors in choosing the right healthcare plan. The benefits of an HSA may not outweigh the negative impact of a high deductible, for those who incur high annual costs and meet the deductible on a regular basis. In those instances, a lower deductible health plan may be more beneficial.

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This blog post, including the views and opinions contained herein, is being provided for informational purposes only, and it should not be relied upon in making any investment decision. This blog post does not constitute investment, tax, accounting, or legal advice, nor does it constitute a recommendation or offer to buy or sell any security or financial product. To the extent that the recipient has any questions regarding the applicability of any information discussed herein to their specific portfolio or situation, the recipient should consult with the investment, tax, accounting, and/or legal professional of their choosing.