Could a Health Savings Account (HSA) be THE best account to invest in?

Today we will be answering questions from Mr. Skeptical (who may or may not be one of my family members) on Health Savings Accounts (HSA). I hope you find this blog post useful and the Q&A format easier to get through than an article laden with IRS statutes, random dates, and dollar amounts.

What is an HSA and why should I care?

The easiest way to understand what an HSA is – is to think of your IRA or 401K, BUT with savings dedicated to medical expenses. We should care because it helps us save on taxes – not once, not twice – but on THREE instances!  More on that later.

I think I’ve heard of these accounts – does my HSA balance disappear at the end of the year if I do not use it?

NO! You are thinking about a Flexible Spending Account (FSA). The balance within an HSA stays in your account as it would in a normal investment account, if you have this account through an employer – you can take it with you when you change jobs or retire.

Can anyone open an HSA and enjoy all these great tax savings you speak of?

Don’t we wish… Unfortunately, you can only enjoy benefits of an HSA if you have a High-Deductible Health Plan (HDHP).

Great, and how do I know if I have one of these HDHPs?

There is a very simple way to tell if you qualify to open an HSA - check your health insurance coverage summary statement or your health insurance website that explains your benefits. For someone who is single, your Health Plan will qualify if you have a deductible of $1,400 or more, with maximum Out-Of-Pocket costs of $7,050. If you are married or have a family, the deductible must be higher than $2,800 with maximum Out-Of-Pocket expenses limit at $14,100.

Sounds like I won this lottery too, so how much can I contribute to an HSA each year and how does it benefit me?

If you are single, you can contribute $3,650. If you are married or have a family and are using the family plan, you can contribute $7,300. For those age 55 or older, you can add another $1,000 which increases the limits to $4,650 for singles and $8,400 for a married couple – on the same HDHP. In situations when both spouses have two different high deductible health plans, are over age 55, and have their own separate HSAs – then each spouse would be able to contribute $4,650 for the total contribution of $9,300.

This is THE FIRST instance of saving on taxes because your contributions to an HSA are tax deductible – just like your IRA or 401K contributions are. In other words, if you and your spouse both put $4,650 into your respective HSAs, and your combined annual income is $100,000 – your taxable income is reduced by $9,300. Now you are paying taxes on $90,700 instead of $100,000!

Okay, but what happens when my investments in an HSA pay dividends or realize Capital Gains, what will that cost me?

This is THE SECOND instance of saving on taxes! Just like in IRAs or 401Ks; what happens in an HSA, stays in the HSA. There is no tax liability for anything that takes place inside of your HSA.

So, it really is like an IRA or a 401K, but meant to cover my Medical Expenses. So, do I owe taxes when I take money out to pay for my Medical Expenses?

THE THIRD instance of saving on taxes is that if you take out money from your HSA to cover “qualifying medical expenses” taxes are not due. That’s right – you get to take a tax deduction when you put money into this account, you pay no taxes on the growth within your account, AND you pay no taxes when you take money out to pay for your medical expenses. It is as if someone took the best features of Traditional and ROTH IRAs and combined them!

It really sounds like if one is eligible, one should definitely take advantage of these benefits… But what’s with the quotation marks around qualifying medical expenses? What can I really use this account for?

Simply put the list is long. One would be best to cross-reference your needs with IRS Publication 969 and 502 which go into far more specifics. Generally, funds can be used to pay for prescribed medications, Over-The-Counter medications, dental treatments, copays, eyeglasses, treatments, and equipment.

Interestingly enough, you generally CANNOT use HSA funds to pay for health insurance premiums. However, you CAN pay for long-term care insurance, COBRA healthcare continuation coverage, and healthcare coverage while receiving unemployment compensation. If over age 65 you can pay for Medicare Part B and D premiums but NOT for Medicare Supplements. Since Medicare is not considered a HDHP – you cannot contribute to your HSA while on Medicare.

Let’s say you have been saving into your HSA for a long time, have a substantial balance… But are healthy and don’t really need all these savings. What can you do with it?

Option #1: You can use these savings for things other than medical expenses – but you will have to pay both a 20% penalty and income taxes on the withdrawn amount. Option #2: Leave it to your spouse – the HSA would behave as if it was your spouse’s account all along. Option #3: Leave it to your estate – your HSA will stop being an HSA and the balance will appear on your estate tax return. Option #4: Leave it to an individual other than your spouse – your HSA account will stop being an HSA and the beneficiary will owe income taxes on the balance.

Final Remarks

This concludes our blog series, Health Care for Early Retirement. If you want more information about obtaining health care before you turn 65, we recommend checking out the video included below. Otherwise, please stay tuned for our upcoming health care series that is in similar vein but covers the period of time during retirement – Medicare.

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Health InsuranceMichael MikonisMichael Mikonis, health care for early retirement