Utilizing every avenue that is available to capitalize on tax savings is always on people's minds (at least during tax filing season) and a health savings account (HSA) is a great one to use. It's the only plan that has a triple tax advantage. That's right, triple!
For most types of accounts that allow contributions to be tax-deferred, there are only a couple advantages. For instance, in a traditional IRA the contributions are generally tax deductible and it grows tax free, but once you make a withdrawal you are taxed on that amount as ordinary income. In a Roth IRA, you don't get the deduction on the contributions, but it grows tax free and the distributions are not taxable when you meet the age and time limit requirements.
With an HSA however, the contributions are tax deductible, it grows tax free, and distributions for qualified medical expenses are not taxed. Not all HSAs are put into investments, but many HSA providers offer that option as well. If you are in fair health and don't necessarily rely on that money for medical expenses, investing HSA deposits for later on down the road might make a lot of sense.
Tax benefits of an HSA
To claim medical expenses on your tax return, you first off have to itemize, meaning you have qualified expenses of more than the standard deduction of $25,100 for a married couple filing jointly, or $12,550 for a single filer in 2021. In addition, medical expenses up to 7.5% of your AGI (adjusted gross income) does not get to count on your itemized deductions, rather just the amount over 7.5% does.
For example, say you are married filing jointly and had qualified expenses to itemize that came to $25,000. In addition, you had $4,000 in unreimbursed medical expenses that you haven't counted towards the $25,000 yet. If your AGI is $60,000, then the first $4,500 (or 7.5% of 60,000) in medical expenses don't get to count towards your itemized deductions. That being the case, you don't get to count any of your medical as a deduction and now don't have enough to itemize.
If you utilize an HSA, then the contributions are not only tax deductible, but any amount that you paid for unreimbursed medical expenses with those contributions are not taxed. This way you for sure are not paying tax with the money you're using for medical expenses. Of course, only the amount coming out of your HSA will not be taxed. If you needed more than what was in the HSA to cover medical expenses, then that would be subject to the itemizing rules.
Additional benefits of an HSA
As was mentioned, the contributions you make to your own HSA are considered pre-tax, and distributions for qualified medical expenses are also not taxed. Any interest, dividends, or capital gains the account makes is not taxed. In addition, if the HSA is through an employer, and they contribute towards your HSA, that is not taxable to you either.
Unlike IRA's or a 401k, there is no age that you are required to start withdrawing from the account. So the account can stay untouched as long as you want. The whole balance carries over each year. It's not a use it or lose it account like an FSA (flexible spending account). Also, the account is completely yours. Even if it is through an employer, it stays in your account if you leave that job. Once you turn 65, distributions from the account can be made for anything, but will be considered ordinary income and subject to tax if not used for medical expenses.
Drawbacks to an HSA
Not everyone can open an HSA. To do so, you have to have a high deductible health plan (HDHP) and no other health insurance. You can't qualify for Medicare, and you also cannot be claimed as a dependent on someone else's tax return.
To be clear, if you already have an HSA you can keep it when you get on Medicare, you just can no longer contribute to the account. However, the account can stay in place and keep growing tax free. Distributions from the account for non-qualified medical expenses before the age of 65 incur a 20% penalty plus tax.
To see if you have a qualifying HDHP, contact your medical insurance company or employer. They will know if your plan qualifies you to have an HSA.
Current HSA contribution limits.
For 2021, contributions for self-only coverage in an HSA are $3,600. For family coverage it is $7,200, and if you are over 55 years old, you can contribute an extra $1,000. These limits include what an employer can contribute, so the total amount to the HSA cannot go over these amounts.
It's an extra retirement account.
An HSA might not be the best option for everyone, and not everyone qualifies to open one. However, if you qualify for one, then opening an HSA could be a very helpful tool. It can be drawn on like a retirement account at the age of 65.
One of the biggest expenses in retirement years are healthcare costs. With an HSA that has been built up over the years, the amount in the account could be substantial and come in very handy later in life to help cover those medical expenses -- not to mention providing a tax-free savings vehicle. If you don't need the HSA for medical expenses, you can still draw on it to supplement your income later on. To me, that's a win win, and something your future self might be very thankful for.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. Our investment philosophy takes a forward-looking approach that may not transpire. The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing involves risk and you may lose your principal.
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