A Health savings Account (HSA) is a tax-advantaged savings account for individuals and families enrolled in a high-deductible health plan. Contributions to an HSA are tax deductible and can be made via payroll deductions, as well as from outside contributions. Withdrawals used to cover qualified medical expenses are not subject to federal taxes. These plans are designed to provide a tax break for the out-of-pocket medical costs associated with a higher deductible health plan, however they also can be used as a great vehicle to save for retirement.
For 2017, a single individual is permitted to contribute up to $3,400, with families permitted to contribute up to $6,750. Furthermore, if you are over age 55, an additional $1,000 “catch-up” contribution can be made. Employers are permitted to make contributions on behalf of their employees, which count towards the annual limit, but also have the benefit of not being counted as taxable income. Unlike a flexible spending account (FSA), contributions to an HSA do not need to be spent down by the end of the year, and are portable as you move from job to job.
Similar to an IRA and a 401(k), contributions to an HSA are tax deductible regardless if you itemize your deductions or take the standard deduction. Money inside an HSA can be invested in a variety of investment vehicles, such as equity and fixed income mutual funds, and the earnings grow tax deferred. Withdrawals from the account are tax free provided they are used to cover qualified medical expenses. This triple tax advantage; tax deductible, tax deferred, and tax free, is a very attractive quality of an HSA. Any withdrawal not used for medical expenses will be subject to income tax and an additional 20% penalty, however the penalty drops off at age 65, meaning non-qualified distributions will only be subject to income tax, replicating the withdrawals of an IRA or 401(k). Unlike an IRA, the Health Savings Account is not subject to required minimum distributions, and there are no income limitations for contributions. For investors who have maxed out their 401(k) plans, IRAs, or are disqualified from contributing to an IRA due to their income, contributing to an HSA is an additional avenue to save for retirement while benefitting from an upfront tax deduction and the additional benefit of tax free medical withdrawals.
Although the Health Savings Account is designed to pay for medical expenses, it can actually make sense not to spend your contributions, and let the investment continue to grow tax deferred. Rather than pulling money out each year to cover qualified medical expenses, pay those expenses out of pocket, and treat the HSA as an investment account. The longer the money remains invested in the HSA, the higher the probability of maximizing your investment returns, giving you significantly more assets to work with in retirement. A major advantage of an HSA is you are not required to take a distribution to reimburse yourself in the same year you incur a qualified medical expense. In other words, you can reimburse yourself for any qualified medical expenses incurred after opening the HSA at any point in the future. This is a significant benefit as you can take advantage of compound tax deferred grow, and withdraw funds completely tax free in the future. Just remember to save your receipts!
There is a wide range of medical expenses that qualify for tax free reimbursement from an HSA. Common expenses include: Vision care (eyeglasses, contacts, Lasik surgery, etc..), wheelchairs, X-rays, childbirth, hospital bills, hearing aids and batteries, guide dogs, ambulance services, dental treatments, disabled dependent care, therapy and counseling, oxygen, annual physicals, in-home nursing services, nursing homes, prescription medication, and many others. HSA withdrawals can also be used tax free to cover insurance premiums. These include continuing coverage under COBRA, qualified long-term care coverage, coverage while receiving unemployment compensation, and Medicare premiums (except supplemental coverage).
Overall, the triple tax advantage of a Health Savings Account makes it a great tool to save for retirement, while at the same time providing tax free distributions for qualified medical expenses. These plans are often misunderstood and overlooked when choosing health plan coverage. Investors can add significant value to their retirement resources by maximizing contributions to an HSA, investing those contributions, and leaving the balance untouched until retirement. The next time you need to decide on health coverage, don’t automatically write off the high- deductible health plan, as it gives you access to the many benefits of an HSA.
* Please note the state of New Jersey currently taxes HSA contributions.
Tom Reynolds, CPA & Matt Reynolds CPA, CFP®
Co-Managing Partners, CRA Financial
Francis C. Thomas CPA, PFS
Robert T. Martin, CFA, CFP®
This article is for informational and educational purposes only and should not be relied upon as the basis for an investment decision. Consult your financial adviser, as well as your tax and/or legal advisers, regarding your personal circumstances before making investment decisions.
This article first appeared in NJ Lifestyle Shore 2017.