Since health savings accounts (HSAs) became available in 2004, we have found that very few people really understand their power. Most of the families we have met with assume that HSAs are the same as a flexible spending account (FSA) which have been around since 1978. The good news is that they aren’t - they are much, much better!
FSAs are pre-tax, which is grand… unless you don’t use them. If you don’t have qualifying medical expenses to reimburse by March 15th of the year after you made the contribution, you forfeit the monies entirely. Worse, there is no way to access the funds unless you have a qualifying medical expenses—deductibles, doctors, hospitals, prescriptions—all not paid by insurance. Not the best system if you are fit and healthy.
HSAs, on the other hand, address all of these issues. You don’t have to spend your contributions each year. There is a lot more flexibility with the term “qualified medical expenses” such as the ability to pay your insurance premiums if you are unemployed. You can even access the funds without a qualifying medical expense. It will cost you 20% plus taxes, but you can do it. And even this penalty is waived if you are 65. And that’s not all...
HSAs even rival your 401(k) or other retirement plan. They aren’t just pre-tax for income tax purposes; they are also pre-tax for FICA and Medicare tax purposes! Moreover, you can invest your contributions just as you would with your retirement plan. Which leads to the most common mistake we see people make with their HSA: They tend to use it like their FSA and never take advantage of the potential tax free growth. And don’t forget about the matching benefits from your employer in your retirement plan. After all, you don’t want to forego a 100% return on your contribution.
So let’s summarize:
- Pre-income tax (Federal and Some States)
- Pre-FICA tax
- Pre-Medicare tax
- Carry from year to year
- Carry from employer to employer
- Can invest for the long-term
- Grow tax free
- Distributions are tax free*
- Can access money even if there is not a qualifying medical expense**
So, what’s the catch?
First, you have to be eligible. You must have a high deductible healthcare plan (HDHP). This can be tricky due to the fact that you may have a high deductible, but it isn’t a “HDHP” plan. If you don’t, don’t throw up your hands just yet. We have found that in many cases it may benefit you to simply change your plan—not only for access to an HSA, but overall cost and benefits. Though take note of your prescriptions - changes to your plan could affect your prescription benefits negatively.
Second, your HSA should go hand-in-hand with your overall planning. Even with all the benefits, an HSA may not be right for you right now. Do you have enough liquidity? Does your family need specialized or recurrent medical care? And, if you are investing, you must consider the level of risk you are taking and whether or not the investments correlate and coordinate with the rest of your portfolio.
Last, there are contribution limitations: $3,500 for individuals and $7,000*** for families. But there is potential good news on the limitations…it’s a hot button for the current administration who wants to expand these limits.
Bottom Line: Like any other tool, it is simply a tool. But even so, it is quite impressive!
*If used for qualified medical expenses.
**This may be subject to a penalty and will be subject to tax.
***Source: IRS, 2019.