A Healthy Investment: Discover the Surprising Benefits of Health Savings Accounts

Healthcare costs in the United States can be quite high, and managing these expenses can be a significant challenge for many people. Fortunately, there is a financial tool available that can help you save money and invest in your future healthcare needs: Health Savings Accounts (HSAs).

This article reviews what HSAs are, their features, and how to maximize their benefits.

What are Health Savings Accounts

A Health Savings Account (HSA) is a separate account that holds money set aside to reimburse you for qualified medical expenses incurred by you or your family members. Similar to retirement accounts, if you are enrolled in an HSA eligible medical plan, you can make annual contributions to the HSA up to a limit based on who is covered under your plan and your age.

Most commonly, people become eligible for an HSA based on their health insurance selection through their employer. However, eligibility for the plan can be much broader and cover retirees, self-employed, or unemployed!

To be eligible for an HSA contribution, you:

• Must be 18 years or older
• Must be covered under a qualified high deductible health plan (HDHP) and cannot be covered under any health plan that is not a qualified HDHP.
  • A HDHP has certain minimum Annual Deductible’s and Maximum Out of Pocket Expense requirements. See Tax Resources – Gilbert Wealth for the latest numbers.
• Cannot not be enrolled in Medicare
• Cannot be claimed as a dependent

Qualified Medical Expenses is actually a special type of expense designated by the IRS. They cover most regular medical expenses such as deductibles and copays, glasses, out of pocket hospital costs and more! The list is quite long and can be viewed here: Publication 502, Medical and Dental Expenses (irs.gov)

When you have a medical expense that qualifies, you have several options to reimburse yourself.

1. Debit Card: Most HSA plans provide a debit card that allows you to pay the out of pocket directly from the account. This is the easiest option. 
2. Reimbursement: If you paid a qualified medical expense out of pocket, you can also transfer money from your HSA to your bank account for the amount of the expense. 

More about Health Savings Accounts: Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans (irs.gov)

8 Amazing Features of Health Savings Accounts

1. Triple Tax Advantaged

HSAs are called triple tax advantaged accounts which means you get three distinct advantages when you put money into them:

Tax Advantage #1: Contributions are Tax-Deductible which means contributions you make reduce your taxable income for tax purposes.

Tax Advantage #2: Growth is Tax-Deferred which means any interest, dividends, or capital gains you make are not taxable in the years you incur them.

Tax Advantage #3: Distributions are Tax-Free if used for Qualified Medical Expenses which means you end up not paying any taxes at all on the contribution, the growth, or the withdrawal!

No other savings vehicle has all three of these features available. 

The benefits above are for Federal Taxes. A few states may impose taxes on contributions, dividends or interest.

If your income is below the FICA thresh hold, you could say that HSA’s are quadruple tax advantaged because contributions are not subject to FICA if deducted from your paycheck. If you are above the thresh hold, you are not paying FICA taxes anyway on the excess.

2. No Income Limits

Another useful feature of the HSA is that it does not impose income limits. While 401k and 403b plans have this feature to some extend (Highly Compensated Employees and Key Employees may have contributions limited), anyone who is eligible for the plan, regardless of income level can contribute.

3. No Spending Requirements

If you are familiar with the similar Flexible Savings Account (FSA), you know that FSA are mostly use it or lose it. If you contribute too much to an FSA and don’t use the balance during the year, you may lose most if not all of your balance. 

Health Savings Account balances are not subject to these time constraints allowing the balance to grow year over year if you do not use it. 

4. Earnings Optional

If you paid attention to the eligibility requirements for HSA contributions, you may have noticed that earnings is not a requirement. That’s right, you do not need earned income (income for wages or self-employment) to make an HSA contribution. Unlike retirement plans (401k, IRA, etc.) that require earned income in order to contribute to them, you can make a contribution from passive income, investment income, and even just from cash sitting in your bank.

5. Reimburse Past Expenses

A relatively unknown feature of an HSA is that you can reimburse yourself, tax-free, for past qualified medical expenses that you paid out of pocket. Only qualified out of pocket expenses that incurred after opening the HSA qualify but this is a neat feature because it allows you to build up a pool of funds in the HSA that you can readily access tax free at any time if you paid these costs with funds other than the HSA.

Why do this? Think back to the 2nd tax advantage, Tax-Deferred Growth. If you paid expenses out of pocket and keep your contributions in the HSA, your are now giving your HSA a chance to grow through investment returns. 

To give you an example of this, let’s assume you contribute $5,000 per year to an HSA and have $4,000 per year in qualified medical expenses. We are going to compare your total economic benefit of two scenarios over 10 years:

Scenario 1 (Most Common): Assume you withdraw $4,000 per year from the HSA to pay the medical expenses leaving you with $1,000 per year extra to invest in the HSA.

Scenario 2: Assumes you pay the $4,000 in medical expenses out of pocket leaving you the ability to invest the full $5,000 in the HSA.

As a result of paying the medical expenses out of pocket, you have accumulated $1,727 more than paying the expenses through the HSA. While this seems small, incremental increases can accumulate over time. 

Additional Assumptions

These two scenarios are not fully equal, so I do assume you save the $4,000 paid out of pocket to a taxable account in Scenario 1. Without this assumption, you are simply committing more dollars (your HSA contribution and paying the full expense out of pocket) to the Scenario 2 strategy which isn’t a fair comparison. Tax rates on capital gains is assumed to be 15% and I assume they are paid every year so that the ending balance of the taxable account is tax free. The growth rate on all accounts is 5% per year. 

6. Special Expenses that Are Qualified

Finally, most people don’t realize that HSA can be used for Medicare Part B, Part C (aka Advantage), or Part D premiums. Long-Term Care premiums, up to certain limits, are also qualified medical expenses and end of life medical costs! A good financial plan accounts for these expenses and an HSA is a great funding source to tackle their rising costs.

7. Age 65 Rule

When you reach age 65, your HSA gains a new ability: the opportunity to withdraw money for non-medical expenses without penalties. Before this age, any non-qualified withdrawal is subject to a 20% Penalty on top of ordinary income taxes on the amount of the distribution. After age 65, you no longer have a penalty on withdrawals but you will still owe ordinary income taxes on the distribution. In a way, this converts the HSA to a Traditional IRA like account.

8. Traditional IRA to HSA Rollover

If you have a Traditional IRA and an HSA but cannot make the yearly contribution amount, you are to rollover money from your Traditional IRA to your HSA tax-free. The rollover is limited to the annual HSA contribution limit and you can only do this once in your lifetime. 

It is a cool trick that is helpful in certain circumstances. 

How to Maximize Your Health Savings Account

1. Know the HSA maximum contribution limit and where HSA’s fall in your savings priority. For the latest limits, check out my Tax Resource Guide here: Tax Resources by Gilbert Wealth
2. Be aware of how the employer match for your HSA works. Any contribution your employer makes reduces your limit but that’s free money!
3. If you have accumulated funds in your HSA, consider developing a long-term investment strategy. Understand that investing is subject to volatility so you want to weigh the costs versus the benefits of investing an HSA.
4. Try to use the HSA entirely for qualified medical expenses to maximize the tax free benefits.
5. Keep track of any qualified medical expenses you paid out of pocket since opening the HSA. Store these in a safe place or digitize them.
6. If you must use the HSA, try to wait until after age 65. 
7. Consider the IRA to HSA rollover if you cannot contribute to the HSA and have upcoming qualifying medical expenses.