Health Savings Accounts (HSAs) can be a great tool for tax savings while you’re working, and can also act as a lesser-known retirement savings vehicle. However, they may not be the best fit for everyone.
How do I qualify for an HSA?
People who shop for their own health insurance must balance several considerations. They seek affordable monthly premiums, a reasonable annual “out of pocket maximum” or annual deductible, and a plan that will provide good coverage for themselves and their families.
In general, the lower the monthly premium, the higher the annual deductible. People who rarely need to visit their doctors and want health insurance coverage mainly in case of an expensive medical emergency, will often opt for lower premium/higher deductible plans. At the same time, they presumably want to ensure that they are not compromising the quality of their insurance plan or restricting their options for medical providers.
In the quest for the perfect balance, one may consider a High Deductible Health Plan (HDHP). HDHPs offer among the lowest monthly premiums because their deductibles are higher than non-HDHP plans. These plans generally appeal to healthy people who have enough funds to pay the high deductible should a health catastrophe strike. HDHPs do cover routine preventative care but the insured will pay entirely out of pocket for all other medical care, up to the annual deductible.
Aside from the lower premiums, one of the most important benefits of an HDHP is that the insured person may participate in a Health Savings Account (HSA). HSAs enable people to contribute pretax dollars to an account that will grow free of federal tax when funds are used for qualified health care expenses. In 2023, you may contribute up to $3,850 (individual) / $7,750 (family) to an HSA and deduct that amount from your annual federal tax liability. Once you reach age 55, you can begin making an additional “catch up” contribution of $1,000. For state tax purposes, please note that different states treat HSAs differently. Consult a Certified Public Accountant to confirm if your state confers the same tax advantaged status to HSAs that the Federal government does. California, for example, does not.
The tax savings may seem modest to start but regular annual contributions can make a significant difference over time and can mitigate the expense of paying out of pocket for medical and health care. You may invest HSA funds in mutual funds or other securities and enjoy tax-free growth when you use funds to pay for qualified medical expenses. The list of allowed expenses is extensive and generally replicates the list of expenses that qualify for the Medical and Dental Expenses Deduction found here. If you use funds to pay for non-qualified expenses, then you will pay tax on the earnings plus a 20% penalty.
Consider a Lesser-Known Retirement Savings Vehicle
You may carry over unused HSA funds indefinitely from year to year with no deadline by which you must use funds. A significant advantage to an HSA is that once you reach age 65, any unused funds in your HSA account may be withdrawn penalty-free for any reason, though you will pay tax on earnings if you do not use funds for qualified medical expenses. With this flexibility for those who are 65 and older, the account can ultimately function as another tax-advantaged retirement account. In other words, the HSA can be thought of as a tool for increasing the maximum dollar amount one saves toward retirement each year. With compounding interest, that relatively small annual contribution can be a difference maker come retirement.
Using an HSA for Medical and Healthcare Expenses
The IRS requires that you save receipts for medical and health care costs and it may ask for them in an audit. The other benefit to saving receipts is that you can keep track of expenses for which you may want to pay out of pocket now and reimburse yourself in later years from your HSA. You are allowed to do that. You are under no obligation to use your HSA funds at the time you receive your medical care. You may repay yourself later—just keep those receipts.
Even with an HSA’s benefits, HDHPs as health insurance are not suitable for everyone. The advantages of lower premiums and having access to a HSA may not outweigh the benefits of being able to visit the doctor often without worrying about how much it costs you out of pocket every single time. You want to be sure that you will not hesitate to obtain vital medical care for fear of paying too much of your own money for it. If you know that you or a family visits the doctor often, then the HDHP/HSA strategy will likely be wrong for you. Talk with your doctor and an insurance expert about your and your family’s medical needs before you make an insurance coverage decision. Also remember that you will never lose your HSA funds, even if you change from an HDHP to a traditional insurance plan at some point.