If you have a High Deductible Health Plan you have probably heard of a Health Savings Account (HSA) and may even have one. HSAs came into existence at the end of 2003 when the Medicare Prescription Drug, Improvement, and Modernization Act was put into law. Even though they’ve been around for almost 17 years they’re still extremely underutilized.
The Employee Benefit Research Institute conducted a study in 2018 that found that the average HSA account balance among accountholders with individual or employer contributions was only $2,803. They also found that 37 percent of HSAs did not receive any contributions for the year and only 14 percent of accountholders maxed out contributions. What’s more, is that only 5 percent of HSAs had invested assets beyond cash.
With the rising cost of health care some of these numbers were less than shocking. When faced with a large out of pocket medical expense it can make sense to use your HSA funds to pay the cost, and if cash flow is an issue this is a no-brainer. But the HSA is an account unlike any other out there and before swiping that handy HSA debit card you should know how your account works.
Triple Tax Advantaged
The HSA has three unique tax advantages that don’t exist together in any other type of account.
The first is the ability to make pre-tax contributions. Sounds a lot like your Traditional IRA but there is one distinct difference, the ability to make a payroll deduction. This is important because if done through a payroll deduction your HSA contribution will also avoid Social Security and Medicare taxes. Additionally, any contributions your employer makes on your behalf are excluded from your taxable income.
The second advantage is tax-free growth within the account. While the account is growing you are not taxed on dividends, interest, or capital gains, again in line with features that exist for IRAs.
But the most unique tax-advantage of the HSA, is the ability to withdraw funds tax-free for qualified medical expenses at any age. Doesn’t matter if you’re 25 or 85, if you have a qualified medical expense you can take money out of your HSA tax-free to pay for it. But you must make sure it’s a qualified expense, or else your distribution will be taxed as ordinary income and you’ll face a 20% penalty. After age 65 the penalty portion goes away, but you’ll still owe ordinary income tax like you would with an IRA distribution.
Investing in Your HSA
HSAs have come a long way since the early 2000s. Most banks that offer HSA products now allow accountholders to invest once they reach and maintain a certain cash threshold, usually a few thousand dollars. The investment options have improved as well, with most providers offering a variety of index funds and passively managed target date funds.
Eligibility & Contribution Limits
To contribute to an HSA, you have to be covered by a High Deductible Health Plan. If you are the only one covered under the plan you can contribute up to $3,550 in 2020. If you are covered under a family plan you can contribute up to $7,100. Additionally, if you are 55 or older you can contribute an additional $1,000. You will lose the ability to contribute to an HSA once you sign up for Medicare or if you are no longer covered by a High Deductible Plan.
Unlike Flexible Spending Accounts (FSAs) offered by some employers, you won’t lose your money at the end of the year if you don’t spend everything in your HSA. Your HSA is also portable, so if you switch jobs or retire you take your HSA with you. Whether or not you are still able to contribute to it depends on what type of new coverage you sign up for.
Finally, HSAs do not have a required minimum distribution age like Traditional IRAs do so you can keep your money growing for longer without being forced to take some of it out each year.
Our healthcare expenses start accumulating the moment we enter the world and you’d never want to put yourself in a serious financial bind today just for the sake of growing your HSA. But, if you are able to treat your HSA like you treat your other investment accounts and give it time to grow, without dipping in too much while you’re saving, it could just become one of the most powerful tools in your financial plan.