Have Your Cake and Eat It Too: Health Savings Accounts
By Brittany Brinckerhoff
The 2022 tax deadline is steadily approaching, meaning it is time to squeeze in any last-minute contributions to your financial accounts, such as Individual Retirement Accounts (IRAs), Health Savings Accounts (HSAs), and Individual 401ks. These accounts all have different rules, benefits, and drawbacks, and whether you should contribute to any, all, or none of them depends on your specific financial situation.
That being said, one of these accounts has unique tax benefits: the Health Savings Account. With an HSA, not only do you get a tax deduction on the money you contribute, but the earnings in the account are tax-deferred and the withdrawals are tax-free if you use the funds for qualified medical expenses*. Tax deductions AND tax-free withdrawals? Almost sounds too good to be true! Read on to learn more about the HSA and why you might want it to be part of your longer-term savings plan.
HSA Basics:
An HSA is an individual savings account that you can contribute to annually ONLY if your health insurance for that year is an HSA-eligible high-deductible health plan (HDHP). For 2022, the contribution limit – including any employer contributions – is $3,650 if your health plan covers you alone ($7,300 if you and your spouse or dependents). These limits generally increase each year, and you can make an extra annual catch-up contribution of $1k if you are over age 55.
You get a tax deduction for any contributions that you make, and the money grows tax-deferred until you withdraw it. Then, if your withdrawals are for a qualified medical expense*, the entire withdrawal is tax-free. However, if you withdraw funds for a non-qualified expense, you’ll pay federal income taxes + a 20% penalty on the withdrawal amount.
Unlike other medical accounts such as a Flexible Spending Account (FSA), the money is NOT “use-it-or-lose-it”. You can leave funds in the account for as long as you want, and the funds are still yours even if you leave your current employer or change health insurance.
*You can read more about the basics of an HSA and find a list of qualified medical expenses at https://www.healthcare.gov/glossary/health-savings-account-hsa/
HSAs aren’t always the right choice:
Tax-free money is great, but using an HSA is not always the best decision for everyone, primarily because you need to be covered by a HDHP to contribute. While the monthly premiums for a HDHP are usually lower than other health insurance options, you could end up spending far more on medical bills just to hit your (high) deductible, which could outweigh the tax benefit of the HSA. So, it’s important to evaluate your health insurance options and the potential max out-of-pocket costs before deciding which plan makes the most sense – and make sure to take into account whether your employer would also contribute to the HSA (gotta love free money from your employer!).
But if you’re generally healthy and you have good cash reserves to help cover unexpected medical expenses, a HDHP with an HSA might be a great fit.
Incorporating HSAs into your longer-term savings strategy:
In addition to getting a nice tax deduction on your contributions, HSAs can also play a role in your longer-term savings plan. Many HSA custodians allow you to invest a portion of the money in your account, so rather than withdrawing everything for medical expenses each year, you could focus on building up the balance and investing it to take advantage of long-term market performance. Reminder: any investment growth within an HSA is tax-deferred (just like a 401k or an IRA) and ultimately tax-free if you use the money for a qualified medical expense*.
On top of that though, the 20% penalty for non-qualified withdrawals goes away once you turn 65. This means that, at worst, you would only have to pay income taxes on a withdrawal after age 65. At that point, this makes the HSA very similar to a pre-tax 401k, with two distinctions:
With the HSA, you can still do tax-free withdrawals for qualified medical expenses
HSAs do not have Required Minimum Distributions, unlike most retirement accounts
One additional quirk is that you can take an HSA distribution at any point to reimburse yourself for previous medical expenses, as long as those expenses were incurred after the HSA was first opened.
So, envision this: you contribute to your HSA but pay all of your medical expenses from your regular cash reserves. You invest the money in your HSA so it can grow over the long term, but you also keep track of your medical receipts so you can tap into the account to reimburse yourself at any time. In retirement, you use the money for medical expenses OR for anything else, without being penalized. Sounds like a pretty nice scenario!
As always though, HSAs are not the right choice for everyone, and you should consider all of the potential cash flow, retirement planning, and income tax implications before making any decisions. Reach out to us today if you’d like to discuss whether an HSA might make sense for you!
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment loss.
Hilltop Wealth Advisors does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation.
The information contained herein is believed to be true as of the date of publication. It may be rendered out of date by subsequent legal or tax-rule changes, as well as variable economic and market conditions.