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If you’re enrolled in a high-deductible health plan at work, you may have been offered the option of an HSA.
So what is an HSA?
It’s a Health Savings Account. It’s designed to help you pay for health care, but it can also be a great way to plan for the future. In this article, I’ll explain the triple tax benefits that HSAs offer, how HSAs work and how you can make HSAs a part of your retirement plan.
If you found this article by searching “what is an HSA,” you aren’t alone. It’s a common internet search term and a question that many Clark.com readers ask.
An HSA is a tax-advantaged savings account that you can use to pay for qualifying healthcare expenses. HSAs can help you cover out-of-pocket costs if your health insurance policy includes a high deductible. You can also invest the money you contribute to your HSA.
HSAs can be a secret weapon within your investment strategy that supplements your retirement plan. It’s a great way to pay for your medical expenses in your retirement years, which I’ll explain in more detail later in this article.
And as I mentioned, HSAs carry some exciting tax benefits that can help make Tax Day less stressful for you.
“You get an upfront tax deduction. The money grows tax-free until you use it. And then when you use the money, it’s tax-free,” money expert Clark Howard says about HSAs. “It’s what accountants refer to as ‘triple tax-free.’”
You must be enrolled in an eligible High Deductible Health Plan (HDHP) to open an HSA. HDHPs tend to feature lower monthly premiums and higher deductibles. In 2022 (and 2023), the IRS defines (and will define) an HDHP as a health insurance policy with:
In addition to those restrictions, you also will not qualify for an HSA if:
Year | 2023 | 2022 | 2021 |
---|---|---|---|
Individual | $3,850 | $3,650 | $3,600 |
Family | $7,750 | $7,300 | $7,200 |
55+ | +$1,000 | +$1,000 | +$1,000 |
The table illustrates the maximum amounts that an individual or family can contribute to an HSA in 2022 and 2023. Keep in mind that these maximums include any contributions that your employer makes. Individuals between 55 and 65 years old can contribute an additional $1,000 per year.
Now that I’ve explained what an HSA is, let’s get into how it works.
Much like your contributions to your company 401(k) or your IRA, the funds you contribute to your HSA are pre-tax. In other words, if you make $50,000 in 2022 and contribute $2,000 to your HSA, you’ll have $48,000 in taxable income.
You can set up your HSA contributions through a payroll deduction. Or you can contribute after-tax dollars and deduct that amount from your gross income on your tax return.
You can’t use your HSA to pay for your monthly health insurance premiums. But you can use it to pay for out-of-pocket medical expenses like deductibles and co-payments.
You can use an HSA-attached debit card, or you can reimburse yourself if you paid for your medical expenses another way. You won’t have to pay any income taxes on the money you took from your HSA to make those payments.
The money in your HSA also grows tax-free. It usually earns a small amount of interest, as it’s in (as evidenced by its name) a savings account. But you can invest the funds in your HSA. And you won’t have to pay taxes on the gains as long as that money remains in your HSA.
Once you turn 65, your HSA will function somewhat like a traditional IRA. You will be able to withdraw money for any purpose. You’ll have to pay income tax on the money you use for something other than qualified medical expenses, but you won’t have to pay a penalty.
You should consider opening an HSA if you:
You may not want to use an HSA if you:
You can find a detailed breakdown of every qualified medical expense on the IRS website.
However, almost all medical and dental services, including preventive care and mental health care, are eligible. The list is expansive, as it’s designed to cover anything you need that’s medically related. Common items include:
Items like vitamins, child care for healthy babies and elective cosmetic procedures are not eligible. So you can’t use HSA funds to pay for that facelift, but you can use them to pay for pretty much anything that a doctor thinks you need in order to stay healthy.
As I cited earlier, research suggests that the average couple may need more than $315,000 to pay for medical expenses in retirement.
You can take pre-tax money, put it into an HSA, invest it, pay no taxes on your profits and then use it to pay for out-of-pocket medical expenses. So it’s an ideal long-term plan to cover medical expenses later in life.
Yet according to research from HSA investment firm Devenir, fewer than 5% of people with HSA accounts were taking advantage of the investment component as of August 2019.
“Almost no one invests their HSA money. They don’t even know how to do that,” Clark says. “An HSA is the equivalent of a savings account. But if you’re someone who can let that money build over the years, you don’t want it sitting in savings. You want it invested.”
As long as you don’t need the money in your HSA to pay for medical bills now or in the near future, you can invest it.
If you get an HSA through your employer, you’re not obligated to invest it through the option that your health insurance company provides. Clark recommends moving your HSA to Fidelity Investments or Lively because of to their low-cost plans.
“A lot of the insurance companies offer horrendously terrible high-cost plans for investing HSA money,” Clark says. “Insurance companies are incredibly awful choices for any form of investing for the future, investing for retirement or investing your HSA funds.”
Investing through an HSA usually involves selecting from a list of low-cost ETFs and mutual funds, which is a strong long-term strategy.
With a Health Savings Account, you can:
You may not like the fact that HSAs may force you to:
Yes. However, if you’re younger than 65, you’ll have to pay a 20% penalty on top of claiming the money as income on your tax return for that year. If you’re 65 or older, your HSA funds act much like an IRA. You’ll pay federal income tax based on your tax bracket but won’t be penalized.
Remember, you can always avoid taxes completely by using your HSA funds only for qualified medical expenses.
The Coronavirus Aid, Relief and Economic Security (CARES) Act permanently reinstated over-the-counter medical products and menstrual care products as eligible expenses for HSA funds.
CARES also allowed you pay for telehealth services before you met the plan deductible. That provision expired Dec. 31, 2021.
HSAs are similar to Flexible Spending Accounts (FSAs) in that they both give you a way to set aside money for health expenses. However, all employees are eligible to participate in FSA plans whether or not they have health insurance. There are other differences as well:
Yes. You can roll over your HSA account into your new employer’s HSA plan, if such a plan exists. You can also transfer your HSA plan to a different custodian, or financial institution, if you’re unhappy with the fees your current HSA custodian charges or you don’t like the investment options it allows.
Clark loves the tax benefits of HSA accounts. He thinks they’re a great way to pay for your post-retirement medical expenses.
Ideally, while you’re still working, you’ve built a rainy-day fund that allows you to pay for out-of-pocket medical expenses without dipping into your HSA. That way you can max out your HSA contributions and allow that money to grow tax-free.
If your employer offers you an HDHP as your option for health insurance, make sure to set up your HSA. And if you’re going to use it to invest, try to avoid the options you get from the insurance company itself.
This post was last modified on December 8, 2022 5:27 pm
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