In 2003, health savings accounts (HSAs) were established as a way for people to save tax-free money for qualified medical expenses. An HSA is a benefit available to individuals who have a qualified high-deductible healthcare plan. This account is one of the most tax efficient ways to save money for the future. We like to refer to it as a triple threat, as it contains three tax advantaged components, rarely found together.
- Deposits into your HSA are pre-tax contributions: meaning, you receive a reduction in your taxable income for every dollar (up to the limit) contributed (similar to an IRA).
- Your contributions will enjoy tax-free growth: meaning, the earnings and appreciation compound without any income or capital gains tax (similar to an IRA and a ROTH IRA).
- You will enjoy tax-free distributions: meaning, you will not pay tax on the funds withdrawn (similar to a ROTH IRA) as long as they are used for a qualified medical expense.
There is simply no other vehicle that provides all three tax advantaged options. Few people have an understanding about how unique, and special, these accounts are for just this reason.
As financial advisors, we’re often asked about tax efficient strategies and savings vehicles. However, we’re rarely asked about HSAs, but have made it a point to always bring them up. Many individuals are using their HSAs to cover current medical costs, only taking advantage of point #1 above, unaware of the long-term benefits. Accumulating, investing and compounding your HSA contributions can provide a significant future benefit, instead of spending it on healthcare expenses today.
For year 2022, the contribution limits are as follows:
- $3,650 for individuals
- $7,300 for families
- $1,000 catch-up contribution for individuals 55 and older (ask me why it’s 55 and not 50, like retirement plans).
Many HSA providers offer access to investments of some kind, but the fees and investment platforms can vary significantly, similarly to a 401(K). The HSA market is still growing annually and you as an investor have a significant role to play in their ongoing success. A platform with a well-designed investment offering provides an opportunity for you to increase your earning potential.
However, if you are dissatisfied with your employer offered HSA platform, the IRS will allow you to make one rollover every 12 months to a provider of your choice. There are a few stipulations and considerations, be sure to consult a professional before directing a rollover.
Qualified medical expenses are designated by the IRS. They include certain medical, dental, vision and prescription expenses you can pay for with your HSA funds. Some qualifying expenses include deductibles, co-payments, flu shots, hearing aids, immunizations, physical exams and many more. However, a recent study estimates that a 65-year-old, healthy couple, will need roughly $266,000 just to cover Medicare premiums, not to mention all the other costs associated with retirement.
When you use your HSA funds to pay for qualified medical expenses, you are not taxed on the purchase. This is the third tax advantage of HSAs, and one that can save HSA accountholders hundreds (or even thousands) of dollars over the life of the HSA.
There’s another little-known benefit of the HSA (the gift that keeps on giving): there is no expiration date to reimburse yourself on qualified expenses. “Save now, cash in later” just means that you can earn tax-free interest on your HSA contributions by paying for qualified medical expenses out-of-pocket and reimbursing yourself later. As long as you keep receipts and proof that you paid the medical expenses out-of-pocket, you can reimburse yourself from your HSA even years after paying the expense.
To take full advantage of the tax benefits that come from having an HSA, you must follow the rules and guidelines set by the IRS. It is your responsibility as the HSA owner to ensure you are spending your HSA funds on qualified medical expenses. Neither your employer nor your HSA provider will ask for documentation to prove you are spending your HSA funds on qualified medical expenses.
The IRS has a broad list of expenses related to medical, dental and vision care that it considers as qualified expenses for HSAs. The following ones might surprise you: Acupuncture, Acne laser treatment, contact lenses and saline solution, expanded dental care, eye laser surgery, guide dogs to assist with disabilities, care for such dogs, hearing aids and batteries, inpatient drug and alcohol treatment, long term care premiums, night teeth guards, Medicare premiums, and many over-the-counter (OTC) medications. With a doctors note, the list expands much further to include: car modifications, CBD and hemp oil, cosmetic procedures, electric toothbrushes, home improvement to accommodate a medical condition, massage therapy, special mattresses, vitamins and dietary supplements, weight-loss programs, wigs, and much more.
To sum up our thoughts on HSA accounts: fund it, invest it and forget it. As you evaluate your allocation to retirement savings, your budget today may not allow you to do it all. However, we suggest you consider carving your HSA contribution out of your 401K, and maximizing its savings now. You should then increase your 401K contributions over time, until you are contributing the maximum to both annually.