What Makes an HSA so Great?

The Health Savings Account or “HSA” is an account intended to fund medical expenses, which provides you with the “best of all worlds” from a tax standpoint.  Similar to a Traditional IRA, you are able to make tax-deductible contributions into the account.  Similar to a Roth IRA, the growth and distributions from the account are tax-free, with one caveat: that you use the funds to pay for qualified medical expenses.  What makes an HSA even more attractive than any retirement account?  Regardless of age, you can withdraw the funds tax & penalty free if they are used to pay for medical expenses.

For people looking to save more for retirement, an HSA can serve as a super tax-efficient vehicle dedicated for retirement healthcare expenses.  According to the Employee Benefit Research Institute, a couple both with median drug expenses would need $158,000 for a 50 percent chance of having enough money, and $271,000 for a 90 percent chance.  If you were to make the maximum contribution of $6,750/year for a family, and use ½ of the contributions to pay for out of pocket medical expenses each year, the account would be worth about $45,000 in 10 years, $134,000 in 20 years, and $309,000 in 30 years assuming a 7% return on investments.  Also, assuming a 25% tax bracket, these contributions would reduce your federal income tax by over $1,680/year.  Making maximum annual HSA contributions could be a very effective way to pre-fund a good portion of medical expenses during retirement.

Can anyone contribute to an HSA?  How much per year can I Contribute?

Unfortunately, not everyone can make HSA Contributions.  In order to qualify for an HSA account, you must be enrolled in a high deductible health plan, defined as plans with a minimum deductible of $1,300 per year for self-only coverage and $2,600 for self-and-family coverage. The maximum out-of-pocket limit is $6,550 for self-only coverage and $13,100 for self-and-family coverage.  For 2017, the maximum contribution to an HSA is $3,400 for self-only coverage and $6,750 for family coverage.  If you’re over the age of 55, you’re allowed an additional $1,000 catch-up contribution.

I’m enrolled in Medicare.  Can I still utilize a health savings account?

Because Medicare is not a high deductible health insurance plan, you are not allowed to make HSA contributions while covered by Medicare.    However, you are allowed to make tax-free distributions as long as they are used to pay for qualified medical expenses.  This is precisely why the HSA is an ideal savings vehicle for retirement healthcare expenses.

Can I use an HSA to invest?

Yes!  Most HSA banks provide an FDIC insured cash equivalent investment, which are currently earning next to nothing.  However there are custodians such as Health Savings Administrators, HSA Bank, and Optum Bank that offer mutual funds as investment options.

HSAs also provide withdrawal flexibility

If fund are used to pay for qualified medical expenses, the withdrawals are tax-free.  Please note that not all health insurance premiums are considered qualified medical expenses for the purposes of HSA withdrawals. Qualified long term care premiums, COBRA, Medicare, and health insurance premiums you pay while you are receiving unemployment compensation are the premiums that are considered qualified medical expenses for the purpose of HSA withdrawals.  If withdrawals are not used for qualified medical expenses, you will have to pay income tax and a hefty 20% penalty on withdrawals.  If you’ve “over saved” into your HSA account, you can avoid the 20% penalty (bill will still owe income tax) on withdrawals taken after age 65.

My employer offers a high deductible health plan.  Switching from my current plan and making HSA contributions is a no brainer, right?

Not so fast.  It’s important to look at the true cost savings of moving to a high deductible plan.  Because high deductible plans increase the amount of potential out of pocket expenses, it’s important to look at how much you expect to utilize your health insurance coverage.   High deductible plans typically work best for relatively healthy people, who aren’t utilizing health insurance benefits very often.   If you’re in poor health, or have children on your plan, make sure you look at the cost savings (in premium reduction, and tax savings) in conjunction with the projected increase in out of pocket expenses.

 

HSA accounts are an “almost too good to be true” vehicle from a tax standpoint.  However, it’s important to make sure it’s worth the increased deductible to justify having access to this vehicle.  If you are in need of assistance in making this decision, consult a CFP® professional.

 

— Adam Glassberg CFP® CIMA®