Today we will be going over Health Savings Accounts, what they are, how to use them, and their pros and cons. We will also discuss some tips and tricks for leveraging the full power of your HSA. On top of that, we will discuss why an HSA is such a powerful tool for those seeking financial independence.
- What is an HSA?
- Eligibility Requirements
- Opening an HSA Account
- Using Your HSA
- HSA Secrets
- Investing Your Funds
- High Deductible Health Plans (HDHP)
- Final Thoughts
What is an HSA? The Basics
To make one thing clear right off the bat, an HSA is not health insurance. An HSA is more like a separate bank account that you use to pay medical expenses.
The primary benefit to an HSA account is that contributions, gains, and disbursements are completely tax-free when used for medical purposes. This means HSA’s have a triple tax benefit.
Medical costs can include anything from medications, doctor visits, lab work, and over-the-counter drugs to birth control, braces, and prescription lenses — Just about anything even remotely ‘medical’ related. See a full list of HSA eligible expenses here.
But don’t go spending your funds on non-medical expenses. Purchasing non-qualified items through your HSA comes with two major drawbacks:
- You will pay tax on the money distributed.
- You will also pay a 20% penalty on the distribution.
Additionally, there is an annual contribution limit for 2019 of $3,500 for individuals. For families, it is $7,000. If you are over the age of 55 you can contribute an additional $1,000 per year as a “catch-up”.
Keep in mind, contribution limits include employer contributions. That means if your employer contributes $500 each year to your HSA, you personally can only add an additional $3,000.
There are four eligibility factors: You —
- Must be on a High Deductible Health Plan (HDHP)
- Cannot be covered under another health plan that isn’t a HDHP
- Are not enrolled in Medicare (only for ages 65 and up)
- Cannot be a dependent on someone else’s tax return
Opening an HSA Account
Some employers will open an HSA account for you with their provider, others will not. The good news is that you can easily open one yourself.
There are several providers available to choose from on the web, check out 20somethingfinance’s list here. Some of them will charge monthly maintenance fees. However, I found Livelyme.com to be simple, quick, and built with a more modern tech-friendly design — Oh, and it’s free!
Using Your HSA
There are two main ways to fund an HSA; through payroll deductions, or after-tax contributions.
In other words, you can have your employer pull out a set amount of every paycheck and put it right into your HSA pre-tax. Alternatively, you can put your own money in whenever you would like and get a tax deduction later on. Either way, the money you put in will effectively not be taxed.
Most HSA’s will issue you a debit card. You can use this card to make purchases at the store, doctors office, or online. This is the most direct method of using your HSA funds.
Another method to using an HSA is through reimbursements.
Say you need to spend $500, but you don’t have the funds in your account. You can pay the amount from your own money then submit the receipt to your HSA for reimbursement. This way you still get the full benefit of the HSA but the flexibility of just using cash.
Now to the good stuff.
Now that you know how an HSA works, let’s get down to some tips and tricks.
Using Your HSA In Retirement
Did you know that once you hit age 65 you no longer need to use your HSA only for medical expenses? That means your HSA essentially turns into a tax-deferred Traditional IRA. However, you can still get the benefit of tax-free medical expenses!
If you are relatively new to retirement accounts in general, I suggest you give this article a read first, 401(k) vs IRA vs Roth IRA: Millennial’s Guide To Retirement 2018. An HSA account is a great addition to any retirement portfolio, but it would be essential that you review all of your options.
According to Fidelity, a couple retiring in 2018 would need $280,000 to cover healthcare costs in retirement. By using an HSA account that has been growing with you, you can offset years of medical expenses.
This is especially important for those seeking financial independence and early retirement. By utilizing the spending power of an HSA you can effectively retire earlier than anticipated. Based on the image above, being able to offset a whole 5 years of expenses will lighten the burden on your saving goals.
2% Cash Back With Reimbursements
Sometimes, you may need to pay for medical costs out of pocket due to a lack funds in your HSA. Typically, providers allow you to submit a receipt for reimbursement if you pay out of pocket.
If your credit card offers cash back, make all of your medical purchases with it. You still get 1-2% cashback and you can submit your expense for reimbursement to your HSA.
All-in-all you get to spend pre-tax HSA funds but still get the benefit of cash back from your credit cards.
Timing Your Medical Expenses
Within the bowels of Internal Revenue Bulletin 2004-50 there is a Q&A regarding the timing of HSA distributions.
The answer states that a distribution in the current year can be used to “reimburse expenses incurred in any prior year.” It also says that “there is no time limit on when the distribution must occur.”
This means that you could save up your medical expenses for later years while your account balance grows. It also means that if you maxed your HSA for the year but have additional medical costs, you could claim them in the following year. Thus still being able to pay your medical expenses with pre-tax dollars.
Investing Your Funds
Investing your HSA funds is a great way to allow you to build wealth. Providers allow you to open an investment account and transfer money to it. While this money is in the investment account, however, it can not be spent on medical expenses.
As mentioned earlier, one of the triple tax benefits is the gains and interest made through investing your funds. As your account balance grows you can use those funds to pay for medical costs, tax free.
High Deductible Health Plans
HDHP’s are becoming more and more common in the workplace since they are cheaper than traditional health insurance.
The IRS, for the purposes of an HSA, considers any health plan with an out-of-pocket deductible greater than $1,350 for a single taxpayer, $2,700 for married, to be a HDHP. The maximum deductible must also be $6,650 and $13,300 for single and married respectively.
A deductible is simply a set amount, that if you spend over that amount, all of your health costs are 100% covered for the year. For instance, if you have health insurance with a $1,500 deductible, and you spend $2,000 that year on doctors visits, insurance would cover the excess $500
HSA accounts become very beneficial to those who have HDHP’s.
Since more of our medical costs are going to be made out of pocket and not covered by insurance, we want to reduce our expenses as much as possible. An HSA allows us to ‘save the tax’ and still pay for these costs.
HSA’s are IRA’s on steroids. They are essentially the same as an IRA with the added benefit of tax free distributions on medical expenses. They can also be used as a retirement vehicle or a saving method.
There really are no major downsides to funding your HSA aside from an additional 5.5 year holding period if you wish to withdraw money for non-medical purposes. However, I would still recommend you fund an HSA alongside a Traditional IRA. They achieve the same goal, but HSA’s have increased benefits.
If you are going to set aside $5,500 to put into your IRA, try splitting your contributions evenly instead of all-or-none.
Thank you for reading!
-Chris, The Main Brain.