Health Savings Accounts – Why everyone should use one! (if you’re eligible)
WHAT IS A HEALTH SAVINGS ACCOUNT?
I love my Health Savings Account and if you’ve ever been in a meeting with our firm you know that from the beginning of every planning engagement, we preach tax efficiency.
Health Savings Accounts were created back in December of 2003 as of way of helping individuals with high deductible health plans save money on medical expenses. What often surprises us is that these accounts have been around for almost two decades, yet we see them not used to their full potential just about every week.
How is it that you can incorporate an HSA into your financial plan as a tax strategy? Wealth-building strategy? Retirement Strategy? Let’s dive into the benefits of the Health Savings Account.
HOW EXACTLY IS AN HSA '“TAX-EFFICIENT?”
Contributions are Tax Deductible: The biggest benefit to your tax bill is the fact that HSA contributions are made on a pre-tax basis. Meaning, if you make $100k a year and contribute $2,000 to an HSA, the IRS shows your adjusted gross income as $98k. This saves you the tax bill on the $2,000 you contributed to the account, which could be as high as 37% if you’re in the highest tax bracket!
Contributions could avoid FICA Taxes: Many people don’t realize that if you make contributions through your employers’ payroll deduction, the contributions are made before FICA Taxes (Social Security & Medicare) are taken out thus saving you an additional 7.65% on every dollar contributed. If your employer doesn’t offer an HSA, but you still have a high deductible health plan, you are still eligible to contribute to an HSA and take advantage of the income tax deduction but not the FICA deduction.
Contributions grow Tax-Deferred: HSA’s act very similar to your IRA or 401(k) retirement account; they grow tax-deferred until you’re ready to use the funds. That means if you contribute $2,000 today and it grows to $2,500, the extra $500 will not be subject to tax until funds are taken out of the account (and could even be tax-free! See next point). The thought process is that during your working years you may be in a higher tax bracket than in retirement. Take the higher deduction today, pay the lower tax rate later. That’s tax arbitrage at its finest! If you’re in the 37% tax bracket and you contribute the full $7,200 for your family (in 2021), that’s a tax savings of $2,664 every year!
Distributions can be Tax-Free: At the beginning of this article, I mentioned that Health Savings Accounts were created to help people with medical expenses. Well, the IRS created a list of qualified medical expenses. If distributions are taken from your HSA to pay for any of those expenses, you will not be required to pay income tax on the distribution! This means you can save money by taking the tax deduction today, avoid paying taxes while the investments grow within the account, AND pay 0 taxes on the distribution when used for a qualified medical expense! TRIPLE TAX EXEMPT FOR THE FINANCIAL PLANNING WIN!!!
OTHER BENEFITS OF AN HSA?
Penalty-Free Distributions after age 65: If you wanted to take money out of your HSA, and it wasn’t to pay for a qualified medical expense, you would be taxed a penalty of 20% on top of your ordinary income tax rate! After age 65, that penalty no longer applies for any type of withdrawal! Be careful though, if it’s not used for a qualified medical expense, you’ll still have to pay ordinary income tax on the distribution, but in retirement many people plan on living in a lower tax rate than in their working years so this still could make sense. We’ve seen many clients use their HSA as an additional savings strategy to be treated like an Individual Retirement Account (IRA) after age 65. This allows them to increase their savings rate today, get the tax deduction, grow tax-free investments for many years, and provides them with another bucket of money to be used in retirement.
This account just gets better and better, doesn’t it? That’s why I love ‘em!
Some employers make contributions on your behalf: Health Savings Accounts are starting to be offered by more and more employers as part of their cafeteria plans. During open enrollment for benefits you may have seen a high-deductible health plan offered along with an HSA. When you dig into the details, we’ve seen employers contribute anywhere from $250 all the way up to $2,500 per year for a family plan! Who doesn’t love free money?
Be sure to not overcontribute to your HSA account because an employer’s contribution counts toward your total annual contribution limit, not in addition to (401(k) matches are different). The annual limit for individuals in 2021 is $3,600 and $7,200 for families. You can check annual limits directly on the IRS website here: IRS Annual Limits
If you forgot to set your contribution limits during open enrollment, don’t worry, you can make a lump sum contribution directly into your HSA for each month of coverage you had. Further, the IRS also has the “last-month rule” which allows you to make an entire year worth of contributions so long as you were HSA qualified for the month of December up until the tax-filing deadline of the following year. For example, if you enrolled in your employer plan and had HSA coverage in December 2021 and were filing taxes in 2022, you could make a lump sum contribution for all of 2021!
Qualified Medical Expenses: The sole reason these accounts were created! HSA’s can be used for all sorts of expenses like routine health, dental, and vision check-ups, and even later in life expenses like long-term care insurance premiums. For a full list check out the IRS site here: Qualified Medical Expenses
Reimburse yourself later: Are you ready to have your mind blown??? You can reimburse yourself for medical expenses at. any. time. ever. Tomorrow, next week, next year, next decade! An awesome wealth strategy could be paying for your day-to-day medical expenses out of pocket, while continuing to contribute to your HSA to take advantage of all the tax benefits. Many, many, many, years down the road, you’ll then be able to reimburse yourself for those accumulated expenses-tax free, and hopefully you’ve seen some growth within the account. Of course, you want to keep meticulous receipts of your qualified medical expenses in the event of an IRS audit.
Pro tip, consider taking pictures on your phone and storing them in a specific folder so you have detailed digital records.
TOP RECOMMENDATIONS TO GET THE MOST OUT OF YOUR HSA:
Max out your annual contribution limit – nothing beats a good savings rate!
Invest the funds – Interest on cash today isn’t doing anyone any favors.
Pay cash for regular medical expenses (when you can) – you can always reimburse yourself later.
Save your receipts – In the event of an IRS audit.
Review annual contribution limits each year – The IRS can increase annual limits.
Consilio Wealth Advisors, LLC ("CWA") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CWA and its representatives are properly licensed or exempt from licensure. The information provided in this article is for educational and informational purposes only and does not constitute investment advice and should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
