HSAs: 3 Cheers for Triple Tax Savings
Here at blooom, we’re huge fans of HSAs, or Health Savings Accounts. No really. We think they’re the best thing since employer matches. While the annual contribution limits may be small—$3,500 if you have self-coverage only or $7,000 for families in 2019—the benefits are mighty. So what’s the big to-do with HSAs, you ask? I have three words for you: triple tax advantaged. Here’s what I mean by that.
- Your contributions are pre-tax, which means that your contributions lower your taxable income (and your tax bill) in the years you contribute.
- Your withdrawals are not taxed if used for qualified medical expenses, which we all have from time to time and will certainly have in retirement.
- Your investment gains are not taxed (again, if used for qualified medical expenses—this is a crucial detail!)
As investment nerds, it’s hard for us to overstate how awesome these benefits are.
Here’s how it works.
Your HSA can be used for any qualified medical expenses, such as annual physicals, glasses, dental care, and much more. Most come with debit cards that allow you to charge your medical expenses to your HSA directly. Alternatively, you can pay with cash or your regular credit/debit card and save your receipt for reimbursement from your HSA at a later date. Here’s an example: before learning about your HSA, you were using after-tax dollars from your checking account to pay for your contact lenses that cost you $50 a week—that money was already taxed at 25% (or whatever tax bracket you fancy). The point is that your tax-free dollars go a lot further!
Although originally intended to help Americans save on ballooning healthcare costs, HSAs can be thought of as a supplemental retirement savings vehicle for many. If you have the cash to pay for your medical expenses at the time that you incur them, you can save your receipts and invest your HSA contributions. Since you won’t have to pay capital gains taxes on HSA money used for qualified expenses, you can let your investments grow over time and get reimbursed retroactively for those past expenses when you actually need the cash.
Side note: If you’re an active blooom client, even though we can’t take over management of your HSA, send us a line if you’d like a recommendation on fund selection—we’ve got your back!
So who’s eligible?
Generally, those with high deductible health plans (HDHPs) are eligible to contribute to an HSA. Here’s the rundown:
|HSA 2019 Eligibility||Deductible minimum||Maximum out-of-pocket costs|
In addition to being covered under a high deductible health plan, to qualify you must also:
- Not be enrolled in Medicare.
- Not be claimed as a dependent on someone else’s tax return.
- Have no other health coverage except what is covered under Other Employee Health Plans.
While many workplace insurance plans have their own HSAs for employees to use, you don’t have to have a workplace plan to be eligible. You simply need to be enrolled in a high deductible health plan and meet the above criteria. It’s also worth mentioning here that unlike some other retirement savings vehicles (we’re looking at you, IRAs), your income won’t disqualify you or ever phase you out from being able to contribute.
How to get set up.
You can set your HSA contributions to come out of your paycheck each month if you use your company plan or you can transfer money over directly from your checking account. As an added benefit, contributions for prior years can be made up until tax day for that previous year, just like with IRAs. Many HSA providers have minimum cash balance requirements—typically $1,000—before you can actually start investing the money.
In most situations, we like to suggest building up and maintaining a cash balance equal to your plan’s annual deductible before you start investing your HSA dollars. This ensures that if you’re using an HSA with a debit card (the most common scenario we see), you always have enough to cover your deductible in an emergency situation without needing to sell any investments. After you hit that deductible equivalent in cash—game on!
Don’t get dinged.
As with all tax advantaged accounts, there are rules to be mindful of when you’re taking withdrawals. The government attaches some strings when there’s tax savings involved because they want to incentivize you to use those accounts for their intended purpose. In the case of HSAs, there’s a 20% penalty if you withdrawal funds prior to age 65 for anything other than qualified medical expenses.
It’s also worth noting that there are several differences between FSAs, or Flexible Spending Accounts, and HSAs. Perhaps most significantly, FSAs generally operate on a use-it-or-lose basis, whereas the money you contribute to your HSA stays with you year after year—don’t confuse the two!
Prioritizing your HSA.
To put in perspective how beneficial these accounts are, our general recommendation is that savers work on funding their HSAs after they’ve met their employer match, started an emergency fund, and paid off all non-mortgage debt. You heard it here—we think your HSA should be funded before your IRA or your 401k (beyond getting that sweet, sweet employer match) and certainly before funding a brokerage account.
Now that you’re up to speed on the HSA basics, find out if you’re eligible to contribute to one and consider taking advantage of the rare opportunity to lock in those triple tax savings.
Written by Laura Wittmer, blooom Financial Advisor
The information is provided for discussion purposes only and should not be considered as advice for your investments. Blooom does not provide tax advice. Consult a tax expert for tax-specific questions.