Health Savings Accounts are an often misunderstood and ignored retirement savings option. They are often confused with the Flexible Spending Accounts some employers offer, which have limitations and are different from HSAs.
Even some of my savviest clients and friends have never heard of HSAs or do not know enough about them and confuse them with FSAs.
What is an HSA?
First introduced in 2004, HSAs offer benefits such as tax-deferred savings and tax-free withdrawals of qualified amounts used for approved medical purposes. HSAs enable people to set aside money to cover medical costs. However, one of the major differences between an HSA and an FSA is that with an HSA, you don’t have to draw down your annual amounts or lose the benefits.
Think of the HSA as a “health 401(k).” The balances roll over every year, even if you change jobs or insurance plans. HSA balances have the opportunity to compound over time and can ultimately supplement your retirement savings. The Employee Benefit Research Institute estimates that a 65-year-old person will need approximately $150,000 in savings just to cover health premiums and prescriptions in retirement.
In short, an HSA offers a triple tax benefit:
• There is a deduction when putting money in them.
• There is tax-free growth on the earnings.
• Withdrawals are tax-free for qualified expenses.
Is an HSA right for you?
Most people access an HSA through their employer, but that is not the only option. Anyone can open an HSA as long as it is a high-deductible health-care plan and you are under the age of 65 (and not on Medicare). You can open an HSA through your bank or other HSA provider.
For singles, health-care plans with a deductible of at least $1,350 and maximum annual total out-of-pocket expenses of $6,650 qualify as high-deductible plans in 2018, according to the IRS. For families, a deductible of at least $2,700 and maximum out-of-pocket expenses of $13,300 qualify for 2018.
In addition to saving for medical expenses in retirement, in keeping with the triple benefits listed above, contributions to the HSA lower the taxable income for that year. However, your first priority should be to select a health plan that best fits your and your family’s needs.
While HSAs have their advantages, their tax benefits alone should not drive health-plan decisions. HSAs aren’t ideal for everyone. If having a high deductible seems too risky or pinches the wallet – or if you anticipate incurring significant health-care expenses – a plan with a lower deductible and lower co-pays might make more sense.
How much can you contribute? In 2018, individuals can contribute up to $3,450 annually and families up to $6,850. For those over 55, there is an additional catch-up contribution of $1,000 per year.
The HSA has become a popular choice for many people to pay qualified medical expenses with tax-free dollars. To better understand which expenses qualify, visit irs.gov and search for Publication No. 502. Examples of qualified medical expenses include but are not limited to:
• Alcoholism treatment
• Ambulance services
• Contact lens supplies
• Dental treatments
• Diagnostic services
• Doctor’s fees
• Eye exams, glasses and surgery
• Fertility services
• Guide dogs
• Hearing aids and batteries
• Hospital services
• Lab fees
• Nursing services
• Prescription medications
• Psychiatric care
• Telephone equipment for the visually or hearing impaired
• Therapy or counseling
HSAs can only be used for qualified medical expenses. What happens if you draw money for expenses that are not qualified medical expenses? If you are 65 or younger, you will owe ordinary income taxes and a 20 percent penalty for nonqualified expenses. After age 65, you can take money out without penalty for any purpose. You will, however, pay taxes on the amounts that are used for nonqualified expenses.