The health savings account (HSA) is an often misunderstood financial planning tool. A health savings account (HSA) is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan (HDHP). Some people confuse it with a flexible savings account (FSA). However, if I told you could grow your account, and never pay taxes when you use the funds for qualified medical expenses, you might like this idea!
Read on and I’ll have a hypothetical example.
The tax advantages of health savings accounts
Who doesn’t like a tax deduction? All tax deductions are not equal, however. Will give you a quick primer. The health savings account The health savings account contributions are similar to qualified retirement plans that you might be familiar with, in that they can reduce your taxable earned income. Let’s use $100,000 income as an example. If you take advantage of an HSA and are eligible for the family maximum contribution in 2016, you can reduce your taxable income by $6750 and only pay taxes on $93,250 if you’re over 55 you can add $1000 and now pay on $92,250. Single taxpayers could see a maximum reduction of $3350 ($4350 if over 55).
The phrase “savings account” is a bit of a misnomer. Savings accounts usually are associated with periods of less than a year rather than more. That distinction affects at what rate you are taxed. Monies held for less than a year are taxed at the same tax rate as your income. If you’re a married filing jointly taxpayer in a $100,000 tax bracket you are subject to a 25% tax rate on your income before any deductions. Those taxpayers in the highest tax bracket pay 39.6%.
Monies held for longer than a year are categorized as long-term. Long-term gains rates stand at 0%, 15%, or 20%, depending upon income. If you are in the highest tax bracket, you cut your tax rate nearly in half.
Why not go one better and make it 0%? You pay no taxes on a health savings account while it is growing. The funds you withdraw from an HSA, for non-qualified medical expenses, will be taxed at your income tax rate, plus a 10% tax penalty. In these ways, it is similar to a qualified retirement plan.
The health savings account as an ATM
Health savings accounts will dispense the amount you asked for as long as you have money in the account and are using it for qualified medical expenses. Outside of paying the premiums on our medical insurance, most people I know don’t budget for copays and coinsurance, and other sporadic health expenses. That being said, one of the reasons that some people have had to claim bankruptcy has been due to severe medical expenses. For many of us, most of our out-of-pocket expenses for medical care will occur later in life. As I learned from my mom when my dad died, the expenses for his health care did not die with him. So how can you plan for these expenses?
The growth benefits
Let’s say you’re 45 years old today and contribute the 2016 family maximum of $6750 maximum for the next 20 years. Additionally, let’s say that hypothetically you are able to achieve a 6% return. At the end of the 20 years, you would’ve invested $135,000 and will now have $263,200.91, nearly doubling your money. Hopefully wouldn’t need to tap into most of that money until say age 85 and would see the money grow even further.
Open benefits enrollment and health savings accounts
Depending upon your company, your only health insurance choice may be a high deductible health care plan (HDHP) or it may be one of the choices on the menu. Remember, you must select the HDHP to qualify for the HSA. You may also be given a choice for a flexible savings account (FSA). If your choice is limited to the FSA, I suggest you try hugging your HR professional and your CFO.
More on that in the next paragraph. You cannot elect an FSA and an HSA. The FSA is the one that is associated with “use it or lose it.” The FSA has no growth opportunities to invest in the market and is seeing it grow with compounding.
A limited-purpose health flexible savings account allows you to participate in a tax-advantaged FSA while also being able to fund your HSA. Your FSA funds would be used for your current year’s qualifying medical expenses. The IRS will usually impose a salary reduction limit per employee. But your employer is not required to adopt the maximum amount. It can be less. Got a working spouse who is also eligible? You can double that amount.
Like the ideas but don’t have time to figure all this out? Contact us so that we can help you customize a plan based on your needs and assumptions.
Tax laws and provisions are subject to change. Hypothetical examples are for illustrative purposes only and are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.