By Eric Rosenberg, WCI Contributor
A Health Savings Account (HSA) is a special type of savings and investment account designed to help you save for healthcare-related expenses. When used as intended, an HSA account offers arguably the best tax advantages of any type of account in your portfolio. But there’s a secret trick that can maximize the value of an HSA for your finance as you get older. Keep reading to learn more about how an HSA works and how to get the best results from it.
What Is an HSA Account?
A health savings account is a tax-advantaged savings and investment account for healthcare expenses. When you have a qualifying health insurance policy, you can contribute to an HSA annually with tax-deductible contributions, meaning you don’t pay any taxes on the contributions when they're made. This is similar to how a 401(k) or a traditional IRA contribution work (which is why we sometimes refer to an HSA as a Stealth IRA). Every qualifying dollar you add this year also lowers your tax bill this year since the money for the HSA is taken out of your paycheck pre-tax.
Plus, unlike a Flexible Spending Account (FSA), which you also could use for healthcare expenses, there's no use-it-or-lose-it policy at year's end. If you have leftover money in your HSA, you can roll that over from year to year.
But the benefits don’t stop there. Withdrawals are also tax-free when you use funds in the account for eligible healthcare expenses (you can also use the HSA funds for non-medical expenses after retirement age, but then you'd have to pay income tax). All of that means you can contribute, grow your account through investments, and withdraw without paying a penny in taxes. It's a triple-tax advantaged account, and as far as I know, there’s nothing else like it.
If earning, investing, and spending tax-free is an exciting idea, here’s how HSAs work and what you need to do to qualify or get started.
How Do HSA Accounts Work?
HSA accounts are standalone savings or investment accounts. You might find one through an employer HSA program, or you can pick your own from a growing list of HSA providers, including Lively HSA and Fidelity Investments.
Who Is Eligible for an HSA?
HSA accounts are not available to all Americans. You’ll need an insurance plan that's termed a high-deductible health plan (HDHP) to be eligible. The minimums change every year, so you’ll want to check the latest stats before contributing. These are the rules for an HDHP for 2022:
If you have a lower deductible or a higher out-of-pocket maximum, your policy is ineligible for an HSA. However, if your deductible and maximums are within those bounds, you’re good to move forward and contribute. Keep in mind, though, that if you or a family member get seriously sick or injured while you have an HDHP, healthcare could get very expensive.
HSA Contribution Limits
Contribution limits also change annually and are set by the IRS. For 2022, the maximum an individual can contribute to an HSA is $3,650. If you’re on a family HDHP, you can contribute up to $7,300 tax-free. Even if that’s a big chunk of your income, it can make sense to save the max. More on that below.
The system also allows for some flexibility. The Last Month Rule states that if a person is deemed eligible for an HSA on the first day of the final month of the tax year (December 1 for most people), that person has eligibility for the entire year (in other words, the previous 11 months). That means the person can then make their entire HSA annual contribution in those final 31 days of the year. The downside, though, is that the person must remain eligible for the HSA through the entirety of the next year (December 31 of the following year for most people), with the exception of disability or death, or the contributions will end up being counted as income (and that person also will be subject to a 10% penalty).
What Expenses Are Eligible for an HSA?
Most medical costs ordered by a doctor or medical professional are eligible for HSA coverage. That includes doctor visits, hospital visits, prescription medications, surgeries, tests, and doctor-ordered medical devices. Even items like contact lens solution and menstrual care products are eligible.
Many over-the-counter and self-ordered medical costs are not included, so it’s best to check with IRS rules or to work with your doctor if you’re planning on a significant expense. COVID-19 legislation expanded access to many over-the-counter products, but it’s still worth checking the list to make sure your purchase is eligible for an HSA if you have any doubts or questions.
Using an HSA to Pay for Healthcare Expenses
Most HSA providers offer a combination of a cash and investment account. The cash is used to buy new investments or to pay for eligible expenses. You can buy and sell investments at any time with no tax implications. The big rule to remember is that you can only withdraw for qualified healthcare expenses.
If your account comes with a debit card, that’s likely the quickest and most convenient way to pay for and to track your HSA-related costs. You can also track receipts yourself and reimburse yourself from your account balance. For example, this method is better for financially savvy households looking to earn credit card rewards and still get the tax benefits of an HSA.
You’re allowed to pay for the expense or reimburse yourself right away, which is what most people probably do. But here’s the secret. You can wait to reimburse yourself later. Like, way later. Like, decades later. Like, in retirement. See where we’re going with this?
Hacking Your HSA into the Best Retirement Account
An HSA isn’t just a health savings account. It’s a secret retirement account in disguise! Hence, the Stealth IRA nickname. If you keep track of those healthcare expenses and hold off on reimbursing yourself until retirement, you’ve just created yourself a completely tax-free retirement account.
If you want to retire early or when you turn 90, you can withdraw funds to reimburse yourself for medical costs from long ago. That’s a fantastic opportunity to save and invest for your future with an almost unheard-of tax benefit. Just remember: Keep track of your receipts.
What About California and New Jersey?
CA and NJ don't recognize HSAs so you actually have to pay state income taxes as they grow as though they were a taxable account. CA and NJ residents still enjoy the federal income tax benefits of using their HSA.
Fitting an HSA into Your Financial Plan
Coming up with an extra $3,000-$7,000 per year for investments isn’t easy for everyone, but the tax benefits here make an HSA a no-brainer if you’re eligible. Even if that means taking a little from your other retirement contributions, the tax benefits here make that switch completely worthwhile, particularly if you’re going to use the account for retirement.
When planning for your retirement or healthcare expenses, an HSA is undoubtedly worth considering. If you’re eligible for this account, the tax benefits overwhelmingly say it’s a good idea to sign up. For a high-income earner, an HSA could end up being one of the best accounts in your portfolio.
If you need extra help with HSAs or other tax-protected accounts, hire a WCI-vetted professional to help you figure it out.
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