Health Savings Accounts: Magnificent, Tax-Advantaged Unicorns
As a fee-only financial planner, I’m THRILLED to utilize the benefits your employer provides. Health Savings Accounts (HSA) are no exception, and you should strongly consider using them if you’re eligible. Unfortunately, not everyone can take advantage of health savings accounts because eligibility is dictated by their health insurance. Simply put, if your health insurance policy has a deductible of $1,400 for single coverage or $2,800 for family coverage, you can contribute to a health savings account. If your health insurance policy has deductibles that are lower, you’re out of luck. Now that you’re combing through your benefits to see what your deductible is (feel free to send it to me to look at), let’s talk about why you should use the HSA if you’re eligible: taxes. The HSA offers unparalleled tax advantages for healthcare AND retirement savings. More about that later. If you’ve made it this far and you’re eligible AND interested in hearing more, you’ll learn how to make the most of your HSA plan, and what to do if your health insurance is a High Deductible Health Plan (read: HSA-friendly), but your company doesn’t offer an HSA.
Who is eligible to use a Health Savings Account?
You need to have a High Deductible Health Plan (HDHP). What does that mean? Your health insurance plan must have a deductible of at least $1,400 for single coverage or $2,800 for family coverage (for 2020). These numbers change from time to time, so be sure to check back every year. Basically, the idea is to allow people with higher deductibles, but lower premiums, to save money in a special account with pre-tax dollars to offset some of the costs of their care. Notably, there are some people that are unfortunately NOT eligible for an HSA. These include people claimed as a dependent on someone else’s tax return, someone enrolled in Medicare, and people covered under someone else’s non-HDHP. If you have family coverage and a deductible for the family as well as for individuals, your deductibles must exceed the minimum deductibles ($1,400 and $2,800, respectively) to qualify as a HDHP, and subsequently be eligible for an HSA. It’s possible that your policy exceeds the threshold for one, but not the other so be sure to check with your administrator if you’re unclear about the deductibles. Clear as mud, right? Feel free to reach out to me to discuss. Basically, the idea is to allow people with higher deductibles, but lower premiums, to save money to offset some of costs of their care. Often, people that utilize HDHP’s are people that don’t expect to frequent the doctor, and are looking for smaller premiums. Another sticky eligibility situation some people run into includes when they were eligible for an HDHP, made an HSA contribution, and then their eligibility changed during the first year. In that case, they may be required to include some of the prior-year contributions in their subsequent-year income. I recommend you speak to your legal and tax professionals for further advice if you think this situation may apply to you. An HSA could still be a great option for you, but you just need to find out more about the ramifications of your changing situation. So, by this point I know you’re dying to ask what should you be doing with the premium savings from having a lower premium and higher deductible?
Why You Should Utilize Your HSA If You Can
HSA’s offer unparalleled tax advantages. Period. Financial Planner mic (calculator?) drop. Whatever. You see, for most accounts, Uncle Sam wants a piece of your money at some point. Depending on the kind of account, the taxation could occur when you contribute, invest, or withdraw money from the account. Uncle Sam will likely get you in one of those three ways, if not more than one. But HSA’s are unicorns. Truly. You can contribute $3,550/year as a single person, $7,100/year for family coverage, and it doesn’t count towards your taxable income for the year, regardless of whether you itemize or not. Furthermore, you can make an additional “catch-up” contribution of $1,000 if you’re over 55 ( for a total of $4,550 for single coverage, $8,100 for family). Also, your employer can make contributions on your behalf (they still count towards the total contribution limit though). So, the HSA is a great way to reduce your taxable income (there’s some nuance to this at the state level) and the contributions you make through payroll may not be subject to FICA (unlike your 401(k)). That’s not all. Your HSA grows tax-deferred. Ideally, you will invest the money in your HSA into some well-diversified mutual funds. Those mutual funds should grow over time, and Uncle Sam won’t be able to touch the interest, dividends, or gains as long as you only take distributions for “qualified medical expenses.” This differs from a taxable brokerage account that would be taxed annually on interest, dividends, and capital gains. It should also mean that without a tax drag, the account can grow faster. Unfortunately, if you take a withdrawal for non-qualified medical expenses before you turn 65, you’ll face a steep 20% penalty and taxation on the withdrawal. This is important because you’re paying for medical expenses with pre-tax dollars. Anytime I can pay a bill with money that Uncle Sam hasn’t had a chance to get his paws on yet, sign me up! Finally, when you’re older and ready to clock out for good, you’re going to want to use this big old pot of money that you’ve saved and invested wisely. After all, $3,550/year compounded at 6% for 30 years ends up being over $290,000. Good news, once you turn 65 you can use the money for WHATEVER you like. No more “qualified medical expense” handcuffs. It is important to note you’ll pay income tax on the distributions if they’re not for “qualified medical expenses,” similar to your Traditional IRA, but you could still enjoy tax-free withdrawals for “qualified” medical expenses. For this reason, many people refer to their HSA as a “stealth IRA.” It really is a sneaky, legitimate way of saving more money for retirement that reduces taxable income today, grows tax-deferred, and could potentially offer tax-free withdrawals if the money is used for “qualified medical expenses.” To boot, the account also doesn’t have any eligibility or phase-outs for income, making an HSA a great tool for higher income savers too.
How to Make The Most of Your HSA and What To Do If Your Employer Doesn’t Offer One
This one is easy. INVEST THE MONEY IN YOUR HSA. For the love of compound interest, please don’t contribute and then let the money sit there earning the default interest rate. Find out what your investment options are, or reach out to me for help reviewing them. You might have a few decades that this money can be invested and growing, so don’t delay. One more thing, obviously this strategy entails utilizing savings outside of your HSA for your medical expenses. After all, if you’re spending the HSA money on medical expenses, there won’t be much left, if anything at all, to invest and grow. This highlights the importance of having a prudent amount of money in your rainy day fund to pay for medical expenses with already-taxed dollars. If you have a HDHP, and are eligible for an HSA, but your employer doesn’t offer one, fret not prudent saver! You can open an HSA elsewhere, but be careful. Your contributions likely will be subject to FICA, so again, I encourage you to talk to your tax professional before proceeding. As you’re shopping for an HSA independent of your employer, be mindful of what investment options the plan has. Also be sure to look into any fees associated with the account and the investment options. Look for low-cost, mutual funds to invest consistent with the rest of your goals. Finally, be very careful whom you name as a beneficiary. If you name anyone other than your spouse, the entire account value will become taxable when you die. Eek! That’s not what we’re looking for here. So, if you have a spouse, it’s probably best to name them as your beneficiary so they can continue to take distributions from the HSA as they age. If you are not married, or you are but you don’t want to leave the HSA to your spouse, proceed with caution. You could be saddling your children, or whomever you leave the account to, with a big tax bill. Please feel free to drop me a line at brendan@meaningfulwealthmanagement.com and tell me whether you liked this, fell asleep, or just want to say hi!