Uncovering the Triple Tax Benefits of Health Savings Accounts (HSAs)
Michael Baum, CFP® RICP®
Vice President & Associate Financial Advisor
Why do higher-income households inquire about Health Savings Accounts? They have heard about what an HSA can potentially offer them: a pool of tax-exempt dollars for health care, a path to tax savings, even a possible source of retirement income after age 65. You may want to look at this option yourself.
Eligibility and Tax Saving Opportunities for an HSA
You must enroll in a high-deductible health plan (HDHP) to have one, a health insurance option that is not ideal for everybody. You fund an HSA with tax-free contributions. Some employers will even provide a matching contribution on your behalf.
HSAs offer you three potential opportunities for tax savings. Your account contributions are tax-free (that is, tax deductible), the earnings in your account grow tax-free, and you can withdraw funds from your HSA, tax-free, so long as they are used to pay for qualified health care expenses, such as deductibles, co-payments, and hospitalization costs. (HSA funds may not be used to pay health insurance premiums.)
HSA Tax Benefits
A large draw for many are the following tax benefits inherent to HSAs:
- Pretax Contributions: Contributions through an employer are always pretax.
- Tax-Free Growth: You can invest the funds after your account balance reaches a certain level.
- Tax-Free Withdrawals: Distributions for qualified health expenses aren't taxable.
At age 65, you can even turn to your HSA for retirement income. Current federal tax law allows an HSA owner 65 and older to withdraw HSA funds for any purpose, penalty free. You can use an HSA to pay Medicare premiums (other than premiums for a Medicare supplemental policy, such as Medigap) or extended-care insurance premiums. No Required Minimum Distributions (RMDs) are ever required of HSA owners. Keep in mind, however, if you take a distribution that is not used for a qualified medical expense, the money may be taxable, and a penalty could apply, depending on your age.
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Why is an HSA Less Attractive for Some People?
The first thing to mention is the related high-deductible health plan. When you enroll in one of these plans, you agree to pay all (or nearly all) of the cost of medicines, hospital stays, and doctor and dentist visits out of your pocket until that high insurance deductible is reached.
The other hurdle is just saving the money. If you pay for your own health insurance, just meeting the monthly premiums can be a challenge, especially if your household contends with other significant financial pressures. There may not be enough money left over to fund an HSA. Also, if you are a senior (or a younger adult) with a chronic condition or illnesses, you may end up spending all of your annual HSA contribution and reducing your HSA balance to zero year after year. That works against one of the objectives of the HSA – the goal of accumulation, of growing a tax-advantaged health care fund over time.
Additionally, unlike a Flexible Spending Account (FSA), which is funded with pretax dollars but must be used by a specific deadline, HSA contributions can remain in your account to be used for future medical bills at any time. In short, this means there is no "use it or lose it" penalty.
Keep in mind that if you spend your HSA funds for non-qualified expenses before age 65, you may be required to pay ordinary income tax as well as a 20% penalty. After age 65, you may be required to pay ordinary income taxes on HSA funds used for non-qualified expenses. HSA contributions are exempt from federal income tax; however, they are not exempt from state taxes in certain states.
How To Use Your HSA
The Internal Revenue Service (IRS) or your HSA provider are great sources when getting started. For example, the IRS recently issued a reminder that at-home covid tests, face masks, and sanitizing wipes can all be purchased, or qualify for reimbursement, through an HSA. In addition, the IRS offers an interactive assessment tool that can take the guesswork out of what qualifies as an HSA-friendly expense.
If you would like to explore opening an HSA, your first step is to consult an insurance professional to see if you can enroll in a qualified HDHP, unless your employer already sponsors such a plan. Finding an HSA provider is next.
Our team at Weiss, Hale & Zahansky Strategic Wealth Advisors is here to assist you in crafting an efficient HSA strategy that aligns with your overall financial goals, using our strategic Plan Well, Invest Well, Live Well™process. Contact us at (860) 928-2341 or schedule a complimentary consultation on our website.
Presented by Vice President, Associate Financial Advisor, Michael Baum, CFP® RICP®. Securities and advisory services are offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. 697 Pomfret Street, Pomfret Center, CT 06259 and 392-A Merrow Road, Tolland, CT 06084. 860-928-2341. www.whzwealth.com.
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