A unicorn is often used symbolically to describe a rarity or a hidden beauty. I want to introduce you to a unicorn found in the financial realm. Not a specific investment that is poised for extraordinary growth, but a type of investment account with extraordinary benefits. Health Savings Accounts, or HSAs, although common and easy to come by, are rarely utilized to their full potential. HSAs offer “magical” tax benefits that are unavailable via other investment vehicles. As perhaps the most underused financial benefit for taxpayers, it is time we look at strategies to utilize the HSA to its full potential.
How HSAs Work
There are usually two options when considering tax status: tax deferred and tax free/exempt.
Tax deferred: Accounts such as a 401(k), 403(b), or IRA earn a tax deduction on their contributions. However, when the money is taken out at retirement, the full amount is taxable at that time.
Tax free/exempt: Accounts such as a ROTH 401(k) or ROTH IRA are taxed on the contributions in the account. However, when the money is taken out at retirement, it will not be taxed. Any growth experienced in the account is untaxed money.
Health Savings Accounts blend tax-deferred with tax-free, creating what is often referred to as “triple tax benefits.” HSAs qualify for a tax deduction when money is deposited in the account, tax-free withdrawals when money is used for Qualified Health Expenses, and tax-deferred status for withdrawals when money is used in retirement for non-medical expenses.
Unfortunately, this benefit is not available to everyone. You must be enrolled in a High Deductible Healthcare Plan (HDHP) to be eligible to make contributions to an HSA. The current requirements to be considered “high deductible” include an annual deductible of at least $1,350 for individuals or $2,700 for families and an out of pocket max of $6,650 for individuals or $13,300 for families. It is worth noting that Christian Healthcare Sharing plans (MediShare, Christian Healthcare Ministries, Samaritan Ministries) do not meet these requirements. If you are participating in one of these plans, you will not be able to make contributions to your HSA, but if you already have an HSA, you can still make withdrawals from the account.
Setting up an HSA account is often part of enrolling in benefits through your employer. If this is the case, you will elect an amount to be deducted from your paycheck each pay period and moved into your HSA (same process as a 401(k)). Account holders may also make one-time contributions throughout the year via check or electronic funds transfer. In 2018, HSAs set their maximum contribution limit per year at $3,450 for individuals and $6,900 for families. When using the account to pay for qualified medical expenses, either use the “debit” card provided for the account or request a reimbursement later.
Once your account grows to a certain threshold (typically around $1,000), you may begin investing the money in your account. Investment options for an HSA mimic those found in a 401(k) or 403(b) account. That being said, consider what you might use your HSA money for before selecting your investments. As with most investments, if you are young and have a retirement account, leaning toward more aggressive investments may be advisable. However, take caution with high-risk investments, as you might need to rely on your HSA funds for health expenses in the short-term future. If this is the case it is advisable to take less risk in your HSA investments than in your retirement accounts.
HSA vs FSA
Flexible Spending Accounts (FSAs) also offer a health savings vehicle to cover medical expenses. Similar to an HSA, FSAs offer a tax deduction in the current year and tax-free withdrawals on medical expenses. For the most part, the similarities end here.
An FSA is only available through an employer while an HSA can be used through an employer or independently.
An FSA does not require a high deductible healthcare plan like an HSA does.
The maximum contribution limit on an FSA is much lower than an HSA at $2,650.
You get access to the full amount up-front in an FSA. For example, if you elect to contribute $2,400 (over the course of the year) to your HSA from your paycheck, you will be adding $200 each month to your account. You will only have access to that money once you contribute it. For an FSA, if you elect to put in $2,400, then you could use that full amount right away even though you contribute (from your paycheck) each month (not all up front).
Finally, an FSA is “use it or lose it.” If you do not use all of the funds that you deferred into your FSA during that year, you lose the remainder. In an HSA account, your balance carries over from year to year.
When utilizing an HSA, it is important to understand you full financial situation. These strategies could make sense for some people’s situation, and not for others. One thing to be aware of is how much you are currently able to save at the end of each month. If you are tight on your budget, and don’t have a lot of room for additional saving, there may be different saving opportunities that would work better for your situation.
Don't forget, many of the tax-benefits come for investing in the account, and not leaving the funds in cash. Consider what your goal is for the money, and try to keep the funds invested based on that goal.
Because HSAs have a tax-free component, the longer there is money in the account, the more it can compound from investment growth. Because of this, you may want to view your HSA as a retirement investment vehicle. You would need to pay your healthcare expenses out of your bank account and not your HSA account, to allow your HSA to continue growing. Typically, there are significant healthcare expenses in retirement that allow you to use the funds tax-free, but if the funds are used for other retirement expenses, they will still be tax-deferred (like an IRA or 401k).
You may be able to contribute to your HSA through payroll deductions. For example, if your employer offers a cafeteria plan where you can make payroll deductions into an HSA, you will avoid paying FICA taxes (or payroll taxes) and receive a deduction on your federal income taxes. Because of this, it is more beneficial to contribute to your HSA through your employer (Payroll deductions) than through one-time checks and transfers throughout the year from your bank account. The amounts that you contribute from your bank account (not through payroll deductions) will not avoid FICA tax, which means you will be paying an additional 7.65% in taxes on that amount.
Keep good records of qualified medical expenses covered through your HSA. Most HSA providers offer a tool to upload receipts and keep track of expenses. Other providers might import information directly from your insurance. Either way, it is important to be able to prove your HSA expenses to the IRS.
There are other strategies that may fit your particular situation. Your financial planner can help you implement more personalized strategies. For example, if you are eligible for catch-up contributions in your HSA (Age 50), you could open two accounts to utilize two catch-up contribution benefits instead of one. If you are interested in seeing how this fits into your financial plan, feel free to schedule an introductory call with me to discuss it together.
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