How to Make the Most of a Health Savings Account

Health Savings Accounts (HSA) are tax-advantaged medical savings plans, which can act like both a personal checking and investment account.  In fact, HSAs are the most tax-advantaged account that exists.  It is the only type of account with the potential for being triple tax-advantaged.

1. Tax deduction when you put money into an HSA.
2. Tax-deferred growth on your investments within the HSA.
3. Tax-free withdrawals when you take money out to pay for qualified medical expenses.

This is as if you combined the benefits of a Traditional IRA and a Roth IRA.  You get to take a deduction when you fund your HSA, the money grows completely tax-free (no taxes on dividends or any appreciation), and if you take money out to pay for qualified medical expenses, it is a completely tax-free withdrawal. Unlike a traditional IRA account, there are no required distributions from an HSA, so the IRS can’t tell you when to take money out. Best of all, there are no income limitations as there are on IRAs.  It is the ultimate account, but like anything in the tax code, there are some rules to be aware of, as well as some unknown strategies you can use to make the most of your HSA!

Who can open an HSA?

For those on Medicare let me save you the time to read this article…there is no HSA eligible plan through Medicare.  For everyone else, there are two key components to determining if you have an HSA eligible health plan: your deductible and your out-of-pocket max.  People often make the mistake of only looking at their deductible and assuming they qualify, forgetting to account for the second qualifier regarding the out-of-pocket max.

2021 Health Plan Requirements for HSA eligibility

High Deductible Health Plan (HDHP)

To qualify for a Health Savings Account, your health plan must have those two factors above.  It must qualify as a high deductible health plan, meaning your deductible is at least $1,400 self-only or $2,800 as a family, and you must have an out-of-pocket max of no more than the above numbers.  Do note that the out-of-pocket number is the max, not the minimum.  This is where many people go wrong with thinking they qualify for an HSA.  For a family in 2021, you need to have a minimum deductible of $2,800 and your maximum out-of-pocket needs to be $14,000 or less.

How much can you contribute to a Health Savings Account?

The amount you can contribute is based on the calendar year, meaning that if you only had an eligible health plan for part of the year, the amount you can contribute to an HSA will be prorated accordingly.  As well, you are eligible to contribute to an HSA plan anytime during the calendar year or even before the tax filing deadline for that year’s tax return.  For the calendar year 2021, you have until the federal tax return deadline of April 15^th, 2022 to fund your HSA.

2021 HSA contribution limits

Often as part of your employee benefits package, your employer may provide an HSA eligible plan and even contribute on your behalf, similar to a 401(k) match.  While I originally said there are three big tax advantages to an HSA, an employer-provided plan has a sneaky fourth benefit.  If you contribute to an employer-sponsored HSA plan through payroll deductions, your contributions will get to avoid payroll taxes.  This can bring the Health Savings Account into the rarified air of being quadruple tax-advantaged!  If you do participate in an HSA plan offered by your work, be aware that the employer contribution counts towards the maximum you can contribute each calendar year.

Should you choose a High Deductible Health Plan?

Like many financial decisions, that is a personal decision.  While an HDHP can make people nervous about having to pay more for medical care if an emergency happens, they also have the benefit of having lower monthly premiums and the ability to contribute to an HSA.  Nobody can predict their own medical future, but one good thing to remember is that our health coverage is temporary and can be adjusted next year or after a qualifying event.  I personally have had HDHPs in the past but switched a couple of years ago to a low deductible family plan on purpose as I knew my wife and I would be hoping to have our first child.  Spoiler alert, we did have a baby girl in October 2019, and I was happy I had a low deductible plan because having babies is expensive!  Nobody knows what their health will be, but often when we know we have an expected life event or surgery approaching, we can be strategic with intentionally choosing our health plan coverage for the following year.  I am still on a low deductible more comprehensive plan personally, because baby number 2 is on the way and expected to arrive in October!  Over the next couple of years, I expect to go back to an HDHP and take advantage of an HSA.

What happens if you withdraw HSA funds for something other than qualified medical expenses?

You will pay a 20% penalty on the amount you withdraw and ordinary income tax also on the withdrawal amount if the funds are not used for a qualified medical expense.  On a positive note, if you are 65 or older, you can withdraw HSA funds for any reason without paying the penalty, however, the funds will still be taxed as ordinary income.  Because of this feature beyond age 65, many people view HSA funds as another potential retirement savings vehicle.  It certainly is, however, keep in mind the best usage of an HSA is to optimize it and achieve the triple tax benefits.

How to make the most of an HSA?

When you open and fund a Health Savings Account, you can choose to leave the funds as cash making the HSA function as a checking account.  You can also choose to invest the funds within the HSA; this option allows for the greatest growth potential for those looking to build a large HSA for long-term goals.  Investing within the HSA is the best way to take advantage of all the tax benefits the account provides.  For those of you that really want to maximize the tax benefits of an HSA, here is a lesser-known strategy.  Keep saving and don’t just leave your HSA in cash, invest the funds within your HSA with the intention to keep the funds invested to take advantage of the long-term growth and maximize the tax benefits.  However, when you have a medical expense, do not use your HSA funds.  Pay from your cash flow or checking account and keep and store your receipts for the medical expenses.  For longevity, finding a digital solution to store your receipts is a good idea.  Money in an HSA rolls over year after year; it is not a ‘use it or lose it’ type of account like a Flexible Spending Account (FSA).  By paying with cash, allows the HSA to continue to grow tax-deferred.  Eventually, when you want to access the funds such as to create retirement income, you can withdraw the funds and treat it as if you are paying yourself back for the previous medical expense you incurred.  The result is that the withdrawal is tax-free since it is technically a reimbursement to yourself from years ago.

What can you use an HSA for?

The IRS defines medical care expenses to include “payments for the diagnosis, cure, mitigation, treatment, or prevention of disease, or payments for treatments affecting any structure or function of the body.”

Outside of medical care, there are many different routine products people don’t realize are qualified HSA expenses such as Band-Aids, therapeutic massages, prescription sunglasses, sunscreen, vitamins, dentures, crutches, and so much more.  Amazon even has a feature to filter their website to show you HSA eligible items.  You can even use your HSA when traveling internationally to pay for treatment in a foreign country as well as any prescribed drugs you purchase and consume in that country.  And if you are stuck internationally and need to get to a different city for a particular level of care or treatment, you can also include the amounts you pay for transportation and even lodging to get to another city if the trip is used for and essential to receiving medical treatment.

With all these benefits of an HSA, it is worth reviewing your health plan to see if it is HSA eligible and if it is make a plan for how to make the most of it.  If you have any questions on checking if your health plan is HSA eligible, or how to set it up properly, feel free to contact us.