Health Savings Accounts: The Tax Hat Trick

In America, taxes and health care are both complex and often confusing systems. Today we are going to break down one small aspect that can have big savings implications and can become a financial planning strategy to add to your arsenal.

In 2003 Health Savings Accounts (HSAs) were created to supplement high deductible health plans so patients can receive tax-advantaged treatment of funds spent on medical expenses. Typically with a tax advantaged account you either pay taxes now (like a Roth IRA) or later (like a traditional IRA) – but what if we told you there is an account where you never have to pay a dime in federal taxes? Sounds too good to be true, doesn’t it? But the way these accounts were created they turned out to be the hat trick of the tax code.

The Trifecta:

  1. Money deposited into an HSA is not taxed, so any money going in becomes a tax deduction for the year in which the funds were deposited.
  2. The funds can be invested in the HSA account and have the opportunity to grow tax sheltered.
  3. If the funds are withdrawn for qualifying health care expenses the growth is not taxed.

Like all tax advantaged accounts there are contribution limits, which tend to increase slightly each year, and like an IRA you can make “catch up” contributions once you reach the age of 55.

The Fine Print

If you withdraw funds for reasons other than health expenses there is a 20% penalty and you need to pay taxes, however, a forth advantage is once a person reaches the age of 65 they can make a withdrawal for any reason without penalty (although the funds are taxed as ordinary income when not used for qualified health expenses). This in effect can make the HSA an extra pre-tax retirement savings vehicle. However, since the funds can be used for things like Medicare premiums and long term care insurance, even if you’re super healthy those saved dollars can typically find a tax-free use in retirement. (Although you can no longer contribute to an HSA once you’re enrolled in Medicare since it’s not a high deductible health plan).

Another benefit to an HSA is the qualifying health expense does not need to be withdrawn the year the expense is incurred. That means if you have a $500 health expense this year you can pay out of pocket for it now and then reimburse yourself from the HSA account in the future, even 5, 10, or 20 years later. So you can actually invest those funds and allow them to grow and then withdraw the reimbursement in the future (just be sure to save your receipts!)

Do the Math

Often times when accounting for costs, you can obtain the same type of coverage as a premium health plan at a lower cost due to the tax savings.  See the comparison chart below for an idea of how these plans work compared to a traditional health plan:

At first glance the high deductible plan appears to cost over 9K with the traditional plan coming in at just under 8K. Once you take into consideration the employer contribution to the HSA and the tax deduction it’s clear the high deductible plan wins for total out of pocket expenses by over $1600 saved.  And that’s if you actually need to use your entire deductible.

Let’s say you had a particularly healthy year and you didn’t need to use your deductible at all (or maybe you only used a portion of it) you still have that money sitting in your HSA. So you spent $6376 on health care but have $6900 sitting in your HSA. You actually made a $524 profit off your health plan! And don’t forget, if you have that money invested it can be earning even more.

How to Take Advantage

Check with your employer to see if you have a high deductible health care option. These plans are typically PPO-style plans but have a larger deductible before coverage kicks in. There has been significant growth in employers that offer high deductible health plans since 2003 and the growth is projected to continue. (Note, an HSA is not a Flexible Spending Account which only has one tax advantage and many limitations, for example, it doesn’t roll over from year to year or to a new employer).

If you are self-employed or otherwise don’t have coverage through an employer you can opt for a high deductible health plan through healthcare.gov.  In this case you don’t have an employer contributing to the cost of the plan but depending on your income level you may qualify for a subsidy.

Once you’ve enrolled in a high deductible health plan the next step is to enroll in a Health Savings Account. Many banks have HSA options. Some of the considerations are the maintenance fees and available investment options. If you are considering an HSA, we are here to help you make these decisions. We can even assist you with opening an account. Contact us any time if you’d like to talk about your options.

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