Taking Advantage of Health Savings Accounts (HSAs)
Written by Harmony Wagner
The number of employers offering health savings accounts (HSAs) as an employee benefit has grown dramatically in recent years. Unfortunately, many people may not be aware of how these accounts work or how to evaluate whether they are a good option.
A health savings account is a tax-advantaged account that can be used to save specifically for medical and health-related expenses. The requirement for contributing to an HSA is that you must be covered under a qualifying High Deductible Health Plan (HDHP). There are a number of reasons to contribute to an HSA, but perhaps the most significant advantage is the tax treatment. Contributions to an HSA are tax-deductible in the year they are made, and the assets grow tax-free. In addition, distributions from this account are tax-free as long as they are used to pay for qualifying medical expenses, which include many different health-related procedures and products. You may be surprised at how many items can be paid for with HSA dollars, from hospital services to orthodontic work to household items such as reading glasses and first aid kits.
If HSA assets are withdrawn for non-qualifying expenses prior to age 65, the distribution is taxable as ordinary income and subject to a 20% penalty as well. After age 65, non-qualified withdrawals are not penalized, but will still be taxed as income.
Another benefit to the HSA is that there are no income limitations, so even high-income earners who may not be eligible to contribute to a traditional or Roth IRA can still utilize an HSA, provided they are covered by a qualifying high deductible plan. The HSA contribution limits for 2019 are $3,500 for individuals and $7,000 for families (with an additional $1,000 catch-up for individuals age 55 and over); for 2020, the limits will be increased to $3,550 for individuals and $7,100 for families. Some employers will contribute to HSAs on their employees’ behalf as an additional benefit, and employer contributions do count towards the annual limit.
Many HSA providers allow the account balances to be invested once they reach a certain balance, but it is wise to keep a portion of the account in cash to cover any unexpected medical emergencies. HSA balances continue to roll over each year and never expire, so they can remain invested for as long as necessary until they are needed.
HSAs are an excellent addition to a retirement savings plan as well. Many retirees are concerned about how they will cover health care costs, and rightly so—according to a Fidelity study1, the average retired couple will incur $285,000 in medical expenses throughout retirement, not including any long-term care costs. An HSA is a great way to save for those expenses in the most tax-efficient manner possible.
The triple-tax advantage and relatively few eligibility requirements make HSAs an appealing savings vehicle for many households. However, it is worth a note of caution regarding high deductible health insurance coverage. The benefits of a HDHP include lower premiums and HSA eligibility, but if you or a family member experiences a significant medical event, you will have to pay more out-of-pocket until you meet the deductible. Ideally, the savings in premiums and taxes will compensate for the high deductible, but it is worth analyzing your household needs before changing coverage to a high deductible plan simply to take advantage of an HSA.
1https://www.fidelity.com/viewpoints/personal-finance/plan-for-rising-health-care-costs