In today’s rising tax environment, if I told you there was an investment account available that provided “Triple-Tax Benefits” you would probably not believe me. So, let me introduce you to the Health Savings Account (also known as HSA) which is still sneaking under the radar. With ongoing health care expenses as one of the highest inflating costs each year, you should consider taking advantage of these amazing accounts, if you qualify.
What is an HSA?
A Health Savings Account is a savings account that allows you to set aside money each year (until you enroll in Medicare- age 65) to save for future medical expenses. If you have an employer or self-obtained health insurance plan that qualifies for participation, you can receive several tax benefits if you (or your employer) make contributions into an HSA. If the funds are used to cover qualified medical expenses when withdrawn, then you pay no tax on the withdrawals. Many HSA plans allow you to invest in mutual funds within the plan which could help the value of the account grow significantly over time.
How do you know if you qualify for an HSA contribution? Your health insurance plan must be considered a High-Deductible Health Plan or HDHP. Most health insurance plans will tell you right from the start if your plan is “HSA Qualified.” If not, here are the three qualifications to confirm your participation:
- You are not enrolled in Medicare
- Your HDHP must have a minimum annual deductible of $1,400 for self-only coverage or $2,800 for family coverage (2021 limits)
- Your HDHP must have an annual cap on out-of-pocket maximum expenses at $7,000 for self-only coverage and $14,000 for family coverage (2021 limits)1
Triple Tax Benefits
So, why are these accounts so great? First, you get an “above-the-line” tax deduction on your federal tax return for your total contributions into the HSA for the year. Second, your contributions and any income or dividend payouts each year grow tax-free while invested in the account. And lastly, when you need to withdraw funds, no tax is due on any of your contributions or earnings just as long as the withdrawal is being applied towards qualified medical expenses. Show me another account with these amazing features… there is none.
What are the Limits?
For 2021, the self-only contribution limit is $3,600 and $7,200 for a family plan. These figures have increased each year in the past, so we expect them to continue to rise in future years as well. Contributions made directly by employers are tax-free and not included for income or FICA taxes. If your employer contributes less than the limit maximum, you can make up the difference.
What Expenses are Covered?
Distributions from an HSA are tax-free if used to pay for qualified medical expenses for you, your spouse, or your dependents. Generally, an eligible expense is anything prescribed by a doctor for a medical condition that returns you to a normal state of health (like doctor bills, prescriptions, eyeglasses, or fillings). Certain insurance premiums are also eligible such as long-term care and COBRA.2
Even though you’re not eligible to make HSA contributions once enrolled in Medicare, you can use existing HSA funds to pay for Medicare premiums for you and your spouse. A more detailed list of qualified medical expenses is available on the IRS website under IRS Publication 502.
Non-Medical Withdrawal Penalties
Funds can be withdrawn tax-free at any age to pay for qualified medical expenses. However, if funds are withdrawn prior to age 65, for non-medical expense purposes, then the withdrawal is subject to ordinary income tax plus a 20% penalty. Once you reach age 65, the 20% penalty is eliminated and you can withdraw funds just like any typical traditional IRA or 401K and just pay ordinary income taxes on the withdrawal.
During retirement, one of the largest costs that many of us will face is the increasing cost of medical insurance supplements, prescription drugs costs, your portion of the Medicare premiums, and rising healthcare costs in general as life expectancies continue to increase. A great way to help supplement these future unexpected costs is to take advantage of the maximum contribution limits into a health savings account. While you likely can’t make a cost or age prediction for something unforeseen as future medical expenses, you can have a plan in place to be prepared for the unexpected.
1J.K Lasser’s Your Income Tax 2021, John Wiley & Sons, Inc., JK Lasser Institute, 2021, pp. 58-65
2HealthSavings.com, “What Can You Pay for with your HSA”, 2021 Health Savings Administrators