One additional question people face when trying to set aside money for the future is where to put it. Savings intended for retirement would go in a different bucket than money for an emergency. While every option has its pros and cons, we sometimes find one that can multitask for us. Then we decide if we want to give up a GREAT option for one goal and settle on a GOOD option for multiple goals. The Health Savings Account can go from great to good in the best possible way.
HSA Introduction
An HSA, or Health Savings Account, is like a savings or investment account specifically dedicated to paying medical expenses. What makes an HSA unique is its unicorn-like tax benefits. Tax-deductible contributions, tax-deferred growth, and tax-free withdraw if used to pay qualified medical expenses. In the right circumstances, this may make them even more beneficial than an IRA.
How do I get an HSA?
In many ways, an HSA is like a consolation prize. It’s what you qualify for if you are stuck with a health insurance plan with high deductibles, cleverly named a High Deductible Health Plan, or HDHP for short. The IRS defines a high deductible health plan as any plan with a deductible of at least $1,350 for an individual or $2,700 for a family. An HDHP’s total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) can’t be more than $6,650 for an individual or $13,300 for a family (per Healthcare.gov). Step one is having an HDHP, provided you don’t have any other health coverage, including Medicare.
Step two is opening an account. If your insurance is through your employer than they may already have a relationship with an HSA provider that you can use. That is easiest because they can payroll deduct it and usually offer it for free. If not try searching the website of your health insurance provider as they will often highlight an option where they have an existing business relationship. You man even find that your local bank offers an HSA plan. The important thing is to make sure it is flexible with how you make contributions (do you need to mail checks, or can you make ACH deposits) and that is has low fees.
What can I spend HSA money on?
While there isn’t a restriction, if you don’t spend it on qualified medical expenses while you are under the age of 65 then you will lose the benefit of a tax-free payout and have a 20% penalty on top of that. After age 65 it works like an IRA and withdraws are taxed at your ordinary income tax rate. While the option is nice, plan on spending it for qualified medical expenses to get the full benefits.
The list of Qualified medical expenses is huge and are covered in IRS Publication 502 (https://www.irs.gov/pub/irs-pdf/p502.pdf). They include common expenses like eye exams or contacts, lab fees, drugs, therapy, and medical equipment. Interestingly, they also include many things you may pay for later in life like long term care insurance premiums, Medicare premiums, hearing aids, and nursing services among others. We’ll get back to those later (wink, wink, nudge, nudge).
What if I don’t spend my HSA funds?
This is where things get interesting. For 2019 an individual can contribute $3,500 and a married couple can stuff away $7,000. In addition, there are a growing number of HSA providers who will allow you to invest your dollars when they get above a certain threshold (usually $500 – $1,000). Buyer beware, as the cost difference between companies varies widely to do this. Assuming you are careful about costs, this is another pool of tax-deferred dollars you can save for the future.
You may even decide that while you are working to go ahead and pay some of those out of pocket costs without using your HSA money. Why would you do that? Because the power of compounding is amazing, and you are going to need money to pay for medical expenses at an even higher rate in retirement when you don’t have a paycheck. The most recent study from Fidelity estimated that the average retired couple would spend $280,000 after tax on health care costs in retirement. Would you rather withdraw from your IRA, pay taxes, then pay medical expenses or pull the money out tax-free from your HSA?
Who benefits the most from deferring HSA dollars?
There are a couple of scenarios where this tends to work best. First, anyone who is maxing out their retirement plan contributions. This is a way to add an additional tax deduction to the return and tax-deferred dollars to the bottom line. Second, healthy individuals/couples who have low annual medical expenses and are already saving at a high rate. Make sure you are at least getting 100% of your match at work first. Third, anyone who likes to keep receipts and pays attention to detail. Under current rules, you can take a withdraw to cover qualified medical expenses, even if they didn’t take place in the current year. This means you could pay out of pocket and save up those receipts for years, then take a tax-free withdraw down the road matched against those prior receipts. You must keep solid records to implement that strategy, but it can give you a lot of flexibility to manage your overall tax liability.
Is an HSA better than an IRA?
In our opinion it certainly can be for many of the situations we highlighted. Unfortunately, it does have a few negatives. One drawback of the HSA is that it can only be passed on to a spouse tax-free. If you pass away and leave it to children it becomes taxable income without the stretch option currently available to IRA beneficiaries. Another is the smaller contribution limits. Finally, since investing HSA assets is rather new the choices are not nearly as good as you would find in a typical retirement account.
All that being said, the triple tax benefits make it an effective tool to plan for spending in retirement. As more and more people are moving to HDHPs to try and lower their insurance costs the popularity of HSAs will only rise. Hopefully, that will lead to more competition and better, lower cost, options for consumers looking to invest their HSA dollars for the future. The scales are in favor of HSAs. We’d even go as far as saying it looks like a VERY good option moving forward.