A Health Savings Account (HSA): Part Of A Healthy Nest Egg
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Key Takeaways
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Health savings accounts (HSAs) offer a tax-smart way to pay for health and medical expenses.
Although HSAs were created in 2003, they remain underutilized. Despite more than half of private sector workers enrolled in an HSA-qualifying insurance plan, just 1 in 5 Americans are covered by an HSA.1,2 Even Microsoft Word's spellcheck function still assumes the word “HSA" is incorrect by autocorrecting “HSA" to “HAS”.
Despite their apparent obscurity, HSAs were designed for common use just like IRAs and 401(k)s; but, instead of helping pay retirement expenses, HSAs were designed to help pay health care expenses.
With contribution limits that can exceed $5,000 to $10,000 yearly, the strategic use of an HSA offers a path to funding a lifetime of healthcare expenses.
Add on a unique combination of tax advantages, and it's clear why an HSA should be part of everyone's financial plan.
We're reviewing what you need to know below.
HSAs Offer a "Triple Tax-Free" Opportunity
HSAs offer a combination of unique federal tax advantages not available elsewhere.
- Tax-Deductible Contributions - Contributions to an HSA reduce your taxable income (or, if made by your employer, are contributed pre-tax and pre-FICA) at the federal level and in most states. This treatment is similar to a traditional IRA or traditional 401(k) contribution.
- Tax-Free Growth - HSA contributions can be used immediately to pay for qualified health and medical expenses, or, contributions can be saved and invested for tomorrow. All growth occurs tax-free for federal income tax purposes and in most states. This treatment is similar to traditional IRA and 401(k) contributions and Roth IRA and Roth 401(k) contributions.
- Tax-Free Withdrawals - Withdrawals used to pay qualified health and medical expenses are tax-free at the federal level and in most states. This treatment is similar to qualified distributions from a Roth IRA and Roth 401(k).
Expect Higher Health Expenses Tomorrow
With health care expenses estimated to average $3,800 yearly (for those ages 19- to 34), increasing to $13,000 yearly (for those ages 65+), the earlier you begin addressing these costs, the easier meeting expenses will be.3
A Great HSA Idea: Contribute Today, Spend Today
Setting money aside for health care costs is appealing but can be unachievable for many who struggle to build savings for more general retirement expenses. Fortunately, HSAs offer valuable tax savings to people of all income levels simply by using the account.
Tip: If you’re paying medical expenses, try to pay them from a health savings account.
You would come out ahead by contributing to an HSA today and spending those same dollars on qualified health expenses. Here's how:
- By contributing to an HSA today, you're ensuring a tax deduction on your contribution.
- By spending those exact same dollars on qualified health care expenses, you’ve 100% deducted a medical expense.
Without the use of an HSA, no one gets a full deduction on their health and medical expenses due to income limitations and deduction-itemization choices. Paying expenses through an HSA avoids these calculations. Dollars set aside in an HSA for health and medical expenses are 100% deductible, tax-free.
Pay Your Way with an HSA
HSAs are accessible via cash reimbursement or via a debit card linked to cover expenses incurred by you, your spouse, plus all dependents claimed on your tax return (children, siblings, parents, and others considered exempt under Section 152 of the tax code).
You might be surprised at all the items your HSA covers.
Pay for Sunscreen, Masks, Advil, LASIK, Etc.
The list of HSA-qualified expenses is extensive, including routine items like medications, sunscreen, masks, Band-Aids, hearing aids, contact lenses, and more obscure items like LASIK eye surgery, just to name a few.
Pay for Deductibles, Copayments, & Coinsurance Costs
You can use your HSA funds to pay medical expenses like doctor and dentist bills, plus bills related to your health insurance plan - deductibles, copayments, and coinsurance.
Pay for Medicare Costs4
Although you cannot make contributions to an HSA after joining Medicare, you can still use funds from your existing HSA to pay for Medicare-related expenses.
For instance, your HSA can pay Medicare premiums for Part B and Part D. This provides a convenient and tax-advantaged way to cover these lifetime costs. (Note: Your HSA cannot pay Medicare premiums for a Medicare supplemental policy, such as Medigap.)
Tip: Pay Medicare Part B and Part D premiums automatically from your HSA. Or, consider periodically reimbursing yourself from your HSA for these costs.
Your HSA can also be a valuable tool in addressing Medicare deductibles and coinsurance. Whether it's the Part A deductible or the coinsurance for Part B services, leveraging your HSA funds can help you minimize the impact on your budget.
Your HSA can come to the rescue by covering Medicare Part D out-of-pocket drug costs. With the rising prices of prescription medications, tapping into your HSA funds can help you better manage these expenses and ensure you have access to the medications you need.
While Medicare provides coverage for many medical services, it generally won’t cover long-term care or a few other specific medical expenses. Your HSA can be a lifeline in such situations by covering qualified medical expenses, including dental care, vision care, hearing aids, Long-Term Care insurance premiums (sometimes called extended care insurance), and more.
A Better HSA Idea: Contribute Today, Grow For Tomorrow
HSAs present a great opportunity for long-term savings and potential growth.
Unlike other healthcare accounts that have use-it-or-lose-it rules, HSA funds carry over indefinitely. There is no need to empty the account by the end of the year. Your balance is yours to keep - even if you change jobs. This creates the potential to accumulate a substantial HSA nest egg.
Opportunity in Growth
Your HSA can be invested just like any other IRA, 401(k), or other investment brokerage account in a wide range of options, including stocks, bonds, money market funds, mutual funds, ETFs, and target-date portfolios.
Investing always carries some risk. The value of your investments can go up or down, and there's a potential for loss. So, make sure you have a separate buffer of cash or stable assets to meet a surprise batch of health costs. You never want the investments in your HSA to decline at the same time as you need them to pay for health expenses.
Opportunity in Contribution Limits
You can make a full-year contribution to an HSA as long as you're eligible to contribute for at least one month during the year. However, you must also remain eligible for the entire next year.
In 2023, the contribution limit for an HSA is $3,850 for individuals and $7,750 for families. Individuals aged 55 and above can make an additional catch-up contribution of $1,000.
In 2024, the contribution limit for an HSA is $4,150 for individuals and $8,300 for families. Individuals aged 55 and above can make an additional catch-up contribution of $1,000.
Tip: In 2024, certain families can contribute $10,300 to a family HSA!
We should all be so lucky to build a pool of HSA funds. "According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2022 may need approximately $315,000 saved (after tax) to cover health care expenses in retirement."5 If you can sock away close to $5,000 to $10,000 yearly, even if only during your highest earning years (typically during your late 40s to 50s), you're well on your way to covering estimated health care costs in retirement and all in a fully tax-free manner.
Opportunity in Remaining Healthy
What if you squirrel all this money away for health care expenses but remain healthy? While you bask in your good fortune, your HSA can also serve as a backup retirement savings vehicle, supplementing other retirement accounts such as 401(k)s and IRAs.
However, unlike other retirement accounts, HSA owners don't face Required Minimum Distributions (RMDs).
While you’re free to withdraw funds from your HSA at any time, withdrawals for non-medical expenses will be taxed as ordinary income, plus the IRS will impose a 20% penalty. Think of this similar to the 10% penalty imposed on withdrawals from a 401(k) before age 55 and from an IRA before age 59.5.
Fortunately, at age 65, the 20% penalty on non-qualified withdrawals no longer applies. You’re free to turn to your HSA for other non-medical expenses, including retirement income (although, just like other pre-tax retirement accounts, withdrawals will still be taxed as ordinary income).
Tip: After age 65, your HSA can be accessed for non-medical expenses similar to any other IRA or 401(k). For those concerned about overfunding an HSA, this provides a defense.
Our Best HSA Idea: Contribute Today, “IOU” Yourself For Tomorrow
A unique opportunity for proactive planning exists for those that can afford to contribute to an HSA today while also paying for qualified health expenses out-of-pocket.
This is common practice; many individuals pay medical expenses with cash, then immediately submit their expense receipt to receive a reimbursement of cash from their HSA. However, since there isn’t a requirement to reimburse yourself in a timely manner, many individuals choose to delay reimbursement. By delaying reimbursement, you maintain the option to reimburse yourself at any time, even years or decades later. You essentially create a tax-free cash IOU payable at your demand.
Tip: If you can afford to pay health care costs out of pocket, do so. Keep your receipts of qualified health expenses, then submit for cash reimbursement at your demand in the years or even decades after the initial expense.
Most receipts are printed on paper that degrades quickly, so make sure to save your receipts in a lasting format, such as within a secure electronic vault (or the Vault available to clients at www.openwindowFS.com/plan).
However, don’t take this idea too far. New legislation can always change the rules, plus it may be difficult or impossible to collect these IOUs if you die holding them.
Are You Eligible for an HSA?
To be eligible to use a health savings account, your employer must offer a high-deductible health plan (HDHP) in which you’re also enrolled.
Even if an HDHP is available or if you're self-employed and considering adding an HDHP, don't jump right in. HDHPs don't work for everyone, particularly those with high healthcare costs.
Before signing up, check the deductible and out-of-pocket costs. HDHPs tend to be higher on both costs when compared to traditional health insurance plans. When you enroll in a high-deductible health plan, you agree to pay all (or nearly all) of the cost of medicines, hospital stays, and doctor and dentist visits out of your pocket until that high insurance deductible is reached. These costs can add up quickly. For instance, the HDHP offered at Open Window has an individual deductible of $3,200 ($6,400 family) and a max out-of-pocket of $6,400 per person ($12,800 family).
Tip: HDHPs are typically utilized by higher earners with free cash flow or younger, relatively healthy people with relatively limited health care expenses.
Finally, while your employer may have chosen an HSA provider, you are not obligated to use it. You can contribute to any HSA of your choice. However, using your employer's designated HSA may come with additional benefits, such as employer contributions and payroll tax savings. Nonetheless, you can perform a rollover to another HSA once a year, temporarily enjoying the benefits of your employer's HSA.
HSA Beneficiary Issues
Make sure your HSA has a designated beneficiary – any beneficiary – on file. Too often, HSAs get overlooked.
Without a beneficiary on file, your estate becomes the beneficiary, and the full value of your HSA is included on your final tax return as taxable income.
Once a beneficiary is selected, make sure you understand the implications of passing your account to them. HSA beneficiary provisions are more restrictive and potentially troublesome than all other tax-favored accounts.
Tip: Ideally, your spouse could be your HSA beneficiary.
While your spouse can inherit your HSA and treat it as if it was their own, all other beneficiaries are forced to distribute the HSA immediately. Not only are the account's health care benefits lost at distribution, but worse, the HSAs pre-tax status is forfeited. The entire balance is taxable as income at once to the beneficiary.
A large HSA can create the potential for an unexpected jump in taxable income, pushing your beneficiary into a higher tax bracket. While some money after-tax is almost always better than no money, a surprise tax bill isn’t one of the last acts we’d choose to share if we could avoid doing so.
Next Steps
Understanding how to leverage your health savings account is essential for maximizing your healthcare dollars. Using your HSA to cover a range of qualified expenses - medical procedures, medications, health insurance premiums, deductibles, coinsurance, etc.- gives you a powerful tool to help manage your health care costs while enjoying potential tax advantages.
With careful planning and strategic use of your HSA, you can embrace your years ahead and focus more on non-financial matters.
We're here to help. Reach out to us anytime at (775) 827-0670 or schedule a time to connect with us at www.openwindowFS.com/connection.
Footnotes
1 - https://www.benefitspro.com/2021/08/20/hsas-in-the-usa-5-states-where-theyre-used-the-most-5-the-least/
2 - https://www.benefitspro.com/2023/02/20/hdhp-enrollment-reaches-more-than-50-of-american-private-sector-workers/
3 - https://www.healthsystemtracker.org/chart-collection/health-expenditures-vary-across-population/#Share%20of%20total%20health%20spending%20by%20age%20group,%202019
4 - Eligibility for Medicare disqualifies you from contributing to an HSA. Since Medicare is assumed to be retroactively obtained six months before eligibility, you can no longer contribute to an HSA within six months of enrolling in any part of Medicare Part A, B, C (often called Advantage Care/Senior Care Plus), or D. You cannot use an HSA to pay Medicare premiums for a Medicare supplemental policy, such as Medigap.
5 - https://www.fidelity.com/viewpoints/personal-finance/plan-for-rising-health-care-costs
Estimate based on a hypothetical opposite-sex couple retiring in 2022, 65-years-old, with life expectancies that align with Society of Actuaries' RP-2014 Healthy Annuitant rates projected with Mortality Improvements Scale MP-2020 as of 2022. Actual assets needed may be more or less depending on actual health status, area of residence, and longevity. Estimate is net of taxes. The Fidelity Retiree Health Care Cost Estimate assumes individuals do not have employer-provided retiree health care coverage, but do qualify for the federal government’s insurance program, Original Medicare. The calculation takes into account cost-sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B (inpatient and outpatient medical insurance). It also considers Medicare Part D (prescription drug coverage) premiums and out-of-pocket costs, as well as certain services excluded by Original Medicare. The estimate does not include other health-related expenses, such as over-the-counter medications, most dental services and long-term care.