Updated for 2022
Health Savings Accounts (HSA) are traditionally thought of as a tool to save money for out-of-pocket medical expenses. Many people do not fully understand how an HSA can reduce future tax bills and many more do not think of it as an investment tool.
How much can you contribute to your HSA?
What is considered a qualified medical expense?
Can you invest your HSA dollars?
How is an HSA different from an FSA?
What are the tax benefits associated with an HSA account?
The Triple Tax-Advantage of a Health Savings Account
The HSA comes with three significant tax benefits:
- Contributions to your HSA are tax deductible.
- Your money grows within the account tax-deferred.
- You can withdraw money from your account tax-free if the funds are used for qualified medical expenses.
This is a great benefit, and we encourage people who have access to this to consider an HSA as part of their overall financial plan.
How Does an HSA Help Reduce Taxes?
Let’s look at the different accounts that allow you to tax-efficiently save for your future and compare the tax benefits of each:
- Traditional IRA or 401(k): Your contribution is tax-deductible — you pay income tax on the money you take from the account in retirement.
- Roth IRA or 401(k): You pay income tax on the money you contribute — the money you take from the account is tax-free.
- Health Savings Account: Your contribution is tax deductible, your money grows tax-deferred, and the money you take from the account is tax-free – as long as it is used for qualified medical expenses.
The Difference between High Deductible Health Care Plans and PPOs
You must have a high-deductible health care plan in order to enroll in a Health Savings Account. A high deductible medical plan (HDHP) means lower premiums and a higher deductible as well as higher out-of-pocket costs. These plans are cheaper than a PPO (Preferred Provider Organization) or traditional group plan. There are trade-offs with each so it’s important that you evaluate each type of plan when thinking about the anticipated medical needs for you and your family.
In some cases, your employer may contribute money to your HSA, if you choose the high deductible plan. The Federal limit in 2022, for combined contributions between you and your employer is $3,650 for individuals and $7,300 for a family. You don’t have to make all contributions in the current tax year and can max out your contribution by April 15,2022 for 2021 taxes
A high-deductible health care plan and HSA can be beneficial for young adults. In your 20’s and 30’s you are typically in good health, don’t expect to incur a significant amount in medical expenses, and you have a longer time horizon for investing.
How Can You Take Full Advantage of Your HSA?
Don’t Spend Your HSA Contributions
This may sound counter-intuitive to how you have traditionally thought of your Health Savings Account. Instead, you might want to think about your HSA as an investment tool to help you achieve your long-term saving goals. Once invested, your HSA money will continue to grow. Unused HSA money doesn’t expire (like an FSA account). You can keep your HSA account if you move or change employers or insurance providers. If you can cover your out-of-pocket medical costs with cash, rather than taking from your HSA, you can invest the funds in your account to help it increase in value, leaving you with more money for health care costs during retirement.
Considerations When Taking Distributions from Your Health Savings Account
You can use your HSA money on non-medical expenses; however, it will cost you. You will have to pay income tax on the money you take from your HSA, and you will incur a 20% penalty on the withdrawal amount.
If you are age 65 or older, you can take money out for non-medical expenses – but, you will pay income tax on the amount you withdraw. You will want to think about other required minimum distributions that you may be taking and consult with a tax professional when making this decision.
A way to avoid paying income tax and incurring a penalty on your HSA withdrawal is to reimburse yourself for a medical expense you paid in the past. It’s important to note that in order to do this, you must make sure to keep receipts for medical expenses paid out-of-pocket. For example, if you have accumulated enough funds in your HSA to cover $10,000 worth of medical costs you paid 5 years ago, you can transfer that money from your HSA to your bank account and not pay any penalties on it. Remember you must include the receipt for each medical expense when you file your income taxes.
At age 65, if you feel you have more money in your HSA then you need for medical expenses, think of your HSA as a Traditional IRA. You can withdraw funds, when you need them, and pay the tax that is due. One of the most important things to keep in mind is that any money you invest in your HSA is yours and it will remain yours until you decide to withdraw it from your account. We can help you understand how much you should invest now and manage distributions in a tax efficient way in retirement.
Questions About Your Health Savings Account?
Schedule time with our team to ask questions.