Why Health Savings Accounts (HSAs) are an Absolute No Brainer
Have you or a family member ever had an illness or health-related issue that wasn’t 100% covered by your health insurance plan, causing you to have to come out of pocket to cover part of the bill?
I’m sure many of us have…And if you haven’t yet, I can almost guarantee that if you live long enough, at some point you will.
This is exactly why this triple-tax advantaged account known as a Health Savings Account (HSA) is an absolute no-brainer for taxpayers covered by high-deductible health plans (HDHPs).
What is an HSA and Do You Qualify for One?
An HSA is a pre-tax savings account that allows you to save for qualified medical expenses while at the same time reducing your taxable income.
To qualify for an HSA, you must be covered by a High Deductible Health Plan (HDHP), which is a health plan with a deductible of at least $1,400 for an individual or $2,800 for a family for both 2021 and 2022.
In addition, an HDHP’s total yearly out-of-pocket expenses can’t be more than $7,000 ($7,050 for 2022) for an individual or $14,000 ($14,100 in 2022) for a family.
Tax Benefits of HSAs
An HSA is a great way to shield taxable income as the contributions to the account are tax-deductible, investments grow tax-free, and the money withdrawn from the account, as long as it is used for qualified medical expenses, will be tax-free.
Individuals can contribute up to $3,600 ($3,650 in 2022) and families can contribute up to $7,200 ($7,300 in 2022) pre-tax to their HSA account regardless of their level of income.
This means a family in the 24% marginal tax bracket will save up to $1,728 in federal tax by contributing to an HSA account. If you’re in the 37% bracket, that’s up to $2,664 in tax savings.
Why HSAs are a No Brainer
We’ve already established that at some point in your life, either you, your spouse, or a child will likely have medical related expenses that won’t be covered by your health plan. This will cause you to come out of pocket and pay for these expenses.
So why not pay for these expenses with tax-deductible contributions made to an HSA?… I know, hard to argue against that.
But it gets better, idle cash sitting in an HSA can be invested and will grow tax-free just like an IRA or 401(k). So not only are contributions tax-deductible, but the money in the HSA can grow tax-free as well, increasing your net worth and acting as a hedge against inflation.
Then, when it comes time to reimburse yourself for qualified medical expenses, the money will also be distributed from the HSA tax-free.
To recap, contributions are tax-deductible, the money then grows tax-free, and then when it’s distributed it’s tax-free. This is why HSAs are a triple-tax advantaged account.
But there is one more thing…
An HSA can also act as a supplemental retirement account because at age 65 you can take penalty-free distributions from the HSA for any reason. However, these distributions will be subject to ordinary income tax rates (but so are traditional IRAs and 401(k)s).
So even if you don’t end up using all of the funds in an HSA for qualifying medical expenses throughout your life, you’ll be able to use the funds in retirement.
The Most Advantageous Way to Use an HSA
Another awesome benefit of HSAs is that you don’t have to reimburse yourself in the year you incur qualifying medical expenses. If you keep the receipts, you can reimburse yourself at a later point in time – even years down the road.
This means you can pay for your out-of-pocket medical expenses yourself, invest your tax-deductible HSA contributions and let them grow tax-free for years, again increasing your net worth, then reimburse yourself tax-free down the line after your contributions have grown significantly.
The Bottom Line
Almost everyone will incur medical expenses throughout their life that aren’t covered by their health insurance plans. By contributing to an HSA and reimbursing yourself for these qualified expenses, you’re effectively making these expenses tax-deductible.
What’s more, if you’re healthy and/or can afford to pay for medical expenses out of pocket today, you can invest the cash in your HSA letting it grow tax-free for years to come. This can not only boost your net worth but also act as a sort of self-insurance for future medical expenses incurred down the line.
And lastly, as if the health-related benefits of an HSA weren’t enough, even if you don’t use all of your HSA funds for medical expenses, it can act as a supplemental retirement account in retirement.
Disclaimer: HDHPs may not be the best health plan for your situation. Be sure to consult your CPA, financial advisor, and primary care specialist prior to choosing a health plan to make sure you choose the most appropriate option for your situation.
