An HSA ((Health Savings Account) is one of the few tax benefits that did not change with TCJA 2017. Tax-wise, they are superior to 401k’s, IRAs, and Roth IRAs because you get a deduction on the front-end and you don’t pay tax on any of the balance, as long as you use your distributions to pay qualified medical expenses.
Congress first gave us the ability to contribute to HSA’s 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. Many people are unaware that their employer offers this valuable benefit – we have seen a big uptick in them in the last five years. 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 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). For 2021, individuals can contribute $3,600/yr and families can contribute $7,200/yr. You can contribute an extra $1,000/yr. for family coverage if you are age 55+.
HSAs allow high-income professionals, such as a physician couple, to save over thousands of dollars over their careers 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 1 of your 1040. This 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. Just save all of those receipts to take distributions from your HSA at a later date – it doesn’t matter if you wait 40 years to take money out of your HSA as long as you have proof of unreimbursed qualified medical expenses during the time you participated in an HSA.
You’ve probably heard the estimates that retirees can expect hundreds of thousands of dollars in healthcare expenses in retirement. What better way than to invest in a “healthcare IRA” for future medical bills? But the good news is that even if you have no healthcare expenses after you retire, you can take distributions to reimburse those medical bills you paid during your working years and the money you take out is all tax free!
For business owners, HSA’s can be offered through work as an employee benefit, which is a win-win for both the employer and the employee. Often, the employer funds part of the annual limit and the employee tops off the account. A little-known tip is that by withholding HSA contributions through your employer, you save not only income taxes but also FICA taxes.
Ten years ago, before HSA’s 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 their advantages, employees are quite receptive to participating in an employer-financed account in exchange for a higher deductible plan.
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, not including extensions.
If you change jobs and your new job offers an HSA and you didn’t have one before, you can contribute for a full year at the end of that year. The catch is that you must continue to qualify for and have access to an HSA through at least December 1 of the following year or you will be subject to the “Last Month Rule” and pay taxes and penalties.
Last tip: your HSA belongs 100% to you beginning with the 1st contribution. That means it is totally portable. If you want to use a different custodian with better fees and investment choices than your employer account, simply roll over your HSA balance from your employer custodian to the firm of your choice periodically. Currently, our recommended HSA custodians are Fidelity and Lively for low fees and zero cash maintenance requirements.