Employees enrolled in a company-sponsored health insurance plan, as well as individuals who have acquired insurance in the private marketplace, have many options to choose from. One option comes in the form of a High Deductible Health Plan (HDHP), which is often associated with a lower monthly premium and a higher deductible (as the name suggests). Another typical feature of the HDHP is the availability of the Health Savings Account (HSA). Studies have shown, however, that while most people are generally aware of these accounts, they are vastly underutilized. However, if used properly, they are one of the best tax-advantaged accounts available.
The HSA is similar to the more commonly known Flexible Spending Account (FSA). Both allow pre-tax dollars to be taken from your paycheck (or deducted from your taxes for private plans) and spent tax-free on healthcare-related costs. This is one of the many ways in which Congress provides a tax break for medical care. The FSA, however, is a “use it or lose it” type of account. The majority of the balance must be spent before the end of the calendar year (IRS limit of $500). The HSA has no such restriction and a balance can be kept and spent at any time. To qualify for an HSS:
- A HDHP must be your only health insurance plan.
- You must not be eligible for Medicare.
- You cannot be claimed as a dependent on someone else’s tax return
Not all plans with high deductibles qualify for HSAs, so be sure to confirm with your provider that the plan includes an HSA option.
The FSA is basically a savings account that must be spent, while the HSA is more closely related to an Individual Retirement Account (IRA), and it can be invested in stocks, bonds, mutual funds, etc. Further, and what makes the HSA extremely unique, an HSA provides triple tax-free benefits – pre-tax contributions, tax-free growth, and tax-free withdrawals – which are hard to beat in any other environment. Of course, the IRS limits how much you can contribute on an annual basis ($3,550 for an individual and $7,100 for families). To ensure the distributions are tax-free with no penalties, they must be used to cover a current medical expense or to reimburse a previous one. Further, if the account owner does not use the balance during his/her lifetime, it can be rolled over to a surviving spouse with the same tax treatment.
The most effective long-term strategy for the HSA is to pay current medical costs out of pocket as they occur, and ensure they were not reimbursed from another source and not previously claimed as an itemized deduction. Essentially, this means that medical costs can occur now and be reimbursed in the future (even many years later in retirement) and still qualify, as long as documentation of the medical expense is maintained and the medical expense occurred after the HSA was originally established.
Alternatively, funds can be contributed to an HSA now and grow tax-free for years before being used for a future medical expense. This strategy benefit does assume, however, that those out-of-pocket medical costs do not qualify for a deduction (currently they must meet a 7.5 percent of AGI threshold), which is the case for most people.
As with any retirement and tax strategy, your individual situation can vary greatly, and we suggest consulting a financial advisor for guidance. But if your current healthcare, cashflow, and tax situation allow, the HSA can be a very useful tool to aid in retirement planning, especially as healthcare costs continue to inevitably rise in the future.