One of the best retirement savings vehicles, and perhaps the most underutilized, is the Health Savings Account. A Health Savings Account, or “HSA”, is a savings account that allow you to put money away on a pre-tax basis for certain future medical expenses. You can think of an HSA as being like an IRA, but specifically designed for your future health care costs. These health care and medical costs include deductibles, co-insurance, copays, glasses, Medicare premiums, and even long-term care insurance, based on certain age-based limits. Health insurance premiums and Medigap insurance are not included in this list.
So…What is the big benefit around Health Savings Accounts?
One of the biggest advantages of utilizing an HSA revolves around its triple tax-free benefits. Contributions into the account are tax deductible (even if you don’t itemize on your tax return), investment growth is tax deferred, and withdrawals for qualified medical expenses are tax free from federal income tax (or in most cases, state tax as well). This is a huge benefit! It is the only account that can enjoy no tax on the way in, no tax while the account is growing, and no tax on the way out! With rising health care costs in retirement, it may be the most tax efficient way to pay for medical costs. This contrasts with utilizing IRA and other qualified retirement plans to pay for said medical costs, and thus, producing taxable ordinary income.
What are the eligibility requirements?
To enjoy these uniquely generous tax benefits and open an HSA, certain criteria must be met. Per the IRS Publication 969 guidelines you must:
- Be covered under a high deductible Health Plan (HDHP) on the first day of the month.
- Have no other health coverage (except was what is permitted).
- You are not enrolled in Medicare.
- You cannot be claimed as a dependent on someone else’s tax return for the year.
For 2021, the deductible minimum is $1,400 for a single person and $2,800 for a family. Additionally, the plan must have a maximum out of pocket limit of $7,000 for a single person and $14,000 for a family. If these criteria are met, the maximum annual contribution to an HSA are $3,600 for an individual and $7,200 for a family. There is an additional $1,000 catch up contribution for those 55 years or older by year end. Remember, if your employer contributes on your behalf, your contributions and your employer contributions must both be within these contribution limits for the year.
How does the Health Savings Account work?
Most employers will offer a bank or custodian to house your HSA. Some popular private choices are Optum Bank and Fidelity. The money you contribute can be accessed through a provided debit card which can be used for payment or reimbursement purposes for medical expenses paid out of pocket.
You can choose to allocate funds in your account in investment choices like mutual funds and exchange traded funds. This can allow for long term growth if a saver has the discipline to not distribute from the account. Another nice benefit is that there is no limit on when you must take funds out. The HSA is portable, and you can take it with you if you leave your employer or retire. Furthermore, any unused balances in the account can be rolled over into the next year.
Who should consider opening a Health Savings Account? What are some of the cons?
High-income earners (young or approaching retirement) that contribute to an HSA can benefit greatly from a holistic planning perspective. In theory, medical expenses in retirement can be paid tax efficiently from their HSA while other living expenses can be distributed from other retirement accounts. For those that are already “maxing” out their retirement plans and have a robust nest egg, the case for opening an HSA can be even more compelling. Make sure to budget for both the out-of-pocket costs until the high deductible is met and for the amount you wish to contribute.
For those that frequently go to the doctor and incur many expensive health care costs, an HSA may not be a good fit for your financial plan. Additionally, if may be difficult to budget for health care costs and maintain the discipline to not use your account and allow your balance to grow. If you are under age 65 and need to take a distribution from your account for non-medical purposes, you will have to pay ordinary income tax plus a 20% penalty. After age 65, this 20% penalty will go away. Finally, you will need to keep good records to prove that your withdrawals were used for qualified health expenses.
Are there any other planning considerations?
Make sure to NOT contribute to an HSA 1 month before signing up for Medicare at age 65. A person receiving Medicare can no longer contribute to an HSA account. If you plan on working at your employer past age 65, you may need to stop contributing potentially up to 6 months prior to signing up for Medicare.
There are many factors that can determine whether an HSA can be a valuable complement to your financial plan. Please email me at ggiardino@jmfranklincompany.com or call our firm at 929-427-0347 to learn more.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
