Do you have an HSA? And if you don't, should you have one? Let's take a look and see.
First of all, HSA stands for Health Savings Account. As the name suggests, it is a way to save and pay for health related expenses. What the name doesn't imply though, is that it is also a way to reduce your taxable income. Who wouldn't want those two things?
Before you can set-up an HSA, you need to qualify to do so. To qualify you need to be enrolled in a high-deductible health insurance plan (HDHP). The U.S. Government has established that for 2018, an HDHP for an individual is a health insurance plan that has a minimum annual deductible amount of $1,350 and a maximum annual out-of-pocket expense of $6,650. If you have a family insurance plan, then the minimum annual deductible must be $2,700 with a maximum annual out-of-pocket expense of $13,300. Just to clarify; out-of-pocket expenses are things such as deductibles, co-pays, and other fees. They do not include health insurance premiums.
So how does this all work and what about reducing your taxable income? Every year you can contribute to your HSA any amount up to the government mandated maximum. Just as IRAs and 401Ks have maximum contribution amounts, so do HSAs. For 2018, the maximum contribution to an HSA for an individual is $3,450. For a family, the maximum contribution is $6,900. Here's an added bonus. If you are 55 years of age or older, you can contribute an additional $1,000 to your individual or family account. On top of this, these contributions are 100% tax deductible!
Another attractive benefit of an HSA is the fact that unlike a Flexible Spending Account (FSA), your HSA balance rolls over from year to year. You do not have to spend it or lose it each year like you do with a FSA. Once you turn 65 and enroll in Medicare, you are no longer eligible to contribute to your HSA, but you can still use the funds in your HSA to pay for out-of-pocket medical expenses. If you decide to use HSA funds on non-eligible expenses, you will have to pay income tax on the amount that you withdraw (plus a 20% penalty if you are under the age of 65).
In total, HSAs have three tax advantages.
Your HSA contributions are tax deductible.
Your money within your HSA grows tax-free.
Withdrawals that are used to pay qualified medical expenses are also free from income tax.
Sounds pretty good. But there are still more benefits to mention. First, money within your HSA can also be invested in mutual funds for the potential for higher growth than if the funds were left in cash. Second, unlike IRAs and other retirement accounts, there are no Required Minimum Distributions (RMDs) once you reach the age of 70 1/2. And finally, if you make your HSA contributions through payroll deductions with your employer, these contributions will not be subject to Social Security and Medicare (FICA) taxes. So in addition to escaping Federal and state income taxes, you will also avoid the 7.65% FICA tax hit. While your 401K contributions escape Federal and state income taxes, they do not escape the FICA tax.
While not the optimal solution for everyone, an HSA is a very attractive way to reduce your health insurance costs while at the same time saving for future medical expenses in a triple tax-advantaged way.
Andrew Tapparo is the president and founder of Tapparo Capital Management, a fee-only financial advisory and investment management firm that specializes in working with individuals, families, and their closely held businesses to develop prudent, long-term strategies that protect and increase wealth.
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