Over the last several years I have witnessed a rise in Employer-offered High Deductible Health Care (HDHC) plans. A Health Savings Account (HSA) typically comes hand in hand with an HDHC offering.
An HSA is Similar to a Flexible Spending Account (FSA). They both provide a means to pay for medical expenses with pre-tax dollars. For a review of the basics, there is a great article here. However, in this post, I want to explain some of the special planning techniques available to people with an HSA.
Triple Tax Savings? I often hear experts get excited over HSA’s because it offers “triple tax savings.” I believe this is an exaggeration, and in my opinion should be thought of as double tax savings. The misconception is created because when HSA’s are used for medical expenses, they are not taxed on contributions, not taxed on earnings and not taxed on withdrawals. Although that is three instances of avoiding tax, the truth is the base-line alternative (an investment account) is only taxed twice, nothing is really triple taxed to begin with. Chart below.
|ACCOUNT TYPE||INCOME||EARNINGS GROWTH||PRINCIPAL (withdrawal)|
|Investment Account||Taxed (Ordinary Income)||Taxed (Capital Gains)||Not Taxed|
|Roth IRA||Taxed (Ordinary Income)||Not Taxed||Not Taxed|
|IRA||Not Taxed||Taxed (Ordinary Income)||Taxed (Ordinary Income)|
|HSA||Not Taxed||Not Taxed||Not Taxed|
Regardless, the tax savings is a big deal and, when compounded over a ten or twenty-year period, it looks amazing. To achieve this tax savings, one needs to open up an HSA account with a custodian that offers investment options. Most of the companies that custody the HSA plan offered through employers do not provide this option. Therefore, one needs to find a bank that does, and roll HSA dollars into that account. The following is a good resource to start an HSA search. Most of the banks that let one invest HSA money do charge monthly fees or a fee if the balance is under a specific threshold. My general rule of thumb is that once the balance is over $5K, it makes sense to move the HSA funds to an account that offers investment options.
Use the HSA for Retirement. An HSA can also be used to supplement a retirement account. If withdrawn when someone reaches 65 years old or later, withdrawals are taxed as Ordinary Income. In this case, it operates the same as an Individual Retirement Account (IRA). One additional advantage is, there are no Required Minimum Distributions (RMD’s) on the HSA. Therefore, one can let the funds sit in the account for a longer period of time, growing tax deferred, without a penalty being assessed.
No Time Limit for Medical Expense Reimbursements. One of the great benefits of an HSA account is there is no time limit to use the HSA dollars for medical costs. For instance, assume I was responsible for $3k of medical expenses this year (copays, deductibles, out of pocket etc.). I could pay out of my checking account to start. Then, if down the road, I needed an extra cash infusion, I could reimburse myself the $3K from the HSA account. It doesn’t matter if this is 3 months, 3 years or 30 years later! That is provided I have kept proper documentation (invoices, receipts).
Closing Thoughts: As a Financial Advisor, I see most individuals using the HSA similar to the FSA. In the contribution year, one pays for medical expenses with HSA funds. I wish I saw more people saving for the long term and not withdrawing from their HSA accounts. The HSA contribution limits for 2020 are $3,550 (individual covered insurance plans) and $7,100 (family covered insurance plans). As medical costs continue to rise, I find it unlikely anybody will have too much saved in their HSA’s. However, if they do, they can always withdraw money from it like an IRA (if 65+) or reimburse themselves for historical medical costs as long as they have saved proper documentation.