Congress first gave us the ability to contribute to HSAs (Health Savings Accounts) in 2004, when we were fighting a war on two fronts and Medicare was our only form of (semi) government-mandated health insurance. In the post-Obamacare era, insurance rates have skyrocketed and consumers are penalized if they don’t have insurance coverage. We have seen a big uptick in and clients who are considering HSAs. If you don’t yet have an HSA, here’s what you should know.
An HSA is a health care nest egg. You contribute to one as you would to an IRA. Unlike your IRA, however, your contributions are deductible no matter how much or how little you earn. While you cannot use your HSA to pay for health insurance (with a few exceptions), you can pay for all other qualified medical costs, such as long-term care insurance, dental work, and hearing aids. Suffice it to say that, other than health insurance premiums, if the IRS allows your medical expense as a tax deduction, you can use your HSA to pay for it.
An HSA is the only kind of savings account that is truly triple-tax free. In addition to an up-front deduction, both the growth (interest, dividends, and capital gains) and your withdrawals are tax-free, as long as you use them for qualified medical costs. There is no limit on how long you can leave your money to grow (i.e. no “use it or lose it” rule) and you can contribute to your HSA until you qualify for Medicare.
You must be covered by a qualified High Deductible Health Plan (“HDHP”) to contribute to an HSA (see 2016 HDHP Limits). An HDHP has low premiums and, theoretically, you should use the money you save on health insurance to fund your HSA. The intent of the law is to make you a cost-conscious consumer since you’ll be spending your own money on medical care. In other words, you may think twice about getting those braces for a slightly crooked smile or be a little more careful when buying name-brand versus generic prescriptions.
HSAs are no-brainers in particular for high-income professionals and business owners, referred to as HNW (High Net Worth). You can contribute up to $7,750 per year for family coverage if you are age 55+ (2016 contribution limits). That means HNW earners, such as doctors, can save over $3,000 by maxing out an HSA, and that doesn’t count state and local taxes, either. That’s the same as having the IRS pay in about 40% of your HSA contribution. Even better, your HSA contribution is an “above the line” deduction, meaning you get to deduct it on page one of your 1040, which reduces your AGI (Adjusted Gross Income) and helps you qualify for other tax breaks!
You can treat your HSA like an extra IRA by investing your contributions rather than emptying out your account to pay for annual healthcare costs. HealthView Services’ 2015 Retirement Health Care Cost Data Report projects that a 55-year-old couple retiring in 10 years can expect to pay $375,864 in lifetime Medicare surcharges. A sound financial plan dictates that you allocate part of your nest egg to funding these costs. What better way than to invest in a “healthcare IRA” for future medical bills?
For business owners, HSAs can be offered through work as an employee benefit, which is a win-win for both the employer and the employee. Ten years ago, before HSAs went mainstream, both employees and employers were more resistant to blowing up the traditional health insurance to try something new. Now that consumers are more familiar with the advantages of HSAs, employees are more receptive to having an employer-financed account in exchange for a higher deductible plan. Typically, the employer funds part of the annual limit and the employee tops off the account. Whether you are an individual funding your own plan or participating in an employer plan, you can contribute to your HSA until the due date for filing your tax return (April 18th this year).