A Health Savings Account (HSA) is a type of account that lets you set aside money on a pre-tax basis to pay for qualified medical expenses. There are several benefits of having an HSA. You can claim a tax deduction for contributions you make to your HSA even if you don’t itemize deductions on your tax return. Contributions remain in your account until you use them, and the earnings on the assets in the account are tax free. Distributions are tax free if they are used to pay for qualified medical expenses. Also, an HSA stays with you if you change employers or leave the work force.
Certain qualifications must be met in order to be eligible for an HSA. I’ll hit the highlights in this post, but I’ll mostly be focusing on using an HSA for planning purposes. You can read about the details of HSA plans at this link.
You must be covered under a high deductible health plan (HDHP) on the first day of the month. For 2019, the self-only HDHP deductible is $1,350, and the family HDHP minimum deductible is $2,700. The annual out-of-pocket maximum for singles is $6,750 and $13,500 for family coverage. You cannot have other health coverage except for a few exceptions, such as disability, long-term care, dental and vision coverage. You cannot be enrolled in Medicare. Finally, you can’t be claimed as a dependent on someone else’s tax return.
Any eligible individual can contribute to an HSA. For an employee’s HSA, the employee, the employee’s employer, or both may contribute to the employee’s HSA in the same year. For an HSA established by a self-employed (or unemployed) individual, the individual can contribute. Family members or any other person also may make contributions on behalf of an eligible individual. For 2019, if you have self-only HDHP coverage, you can contribute up to $3,500. If you have family HDHP coverage, you can contribute up to $7,000. If you are an eligible individual who is age 55 or older at the end of the tax year, your contribution limit is increased by $1,000. Contributions to an HSA must be made in cash. Contributions of stock or property aren’t allowed.
You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax. You don’t have to make withdrawals from your HSA each year. If you are no longer an eligible individual, you can still receive tax-free distributions to pay or reimburse your qualified medical expenses. Qualified medical expenses are those expenses that generally would qualify for the medical and dental expenses deduction.
These unique characteristics of an HSA account can provide a very powerful retirement planning tool. An HSA is the only savings account offering the benefits of both pretax contributions and tax-free distributions. Financial advisors are always touting the benefits of compounding interest and long-term investing. The same is true when it comes to HSAs. To really maximize the benefits of an HSA, you should contribute the max each year, and pay your medical expenses out of savings other than your HSA. By doing so, you’ll be opening the door to two retirement strategies.
First, an HSA distribution does not have to occur in the same year that the qualified medical expense occurred. However, the qualifying medical expense must have occurred after the HSA was established. Therefore, you can collect all of your qualified medical expense receipts and then reimburse yourself years later and receive a tax-free qualified medical expense reimbursement distribution. In fact, the reimbursement distribution can even happen after you have left the HDHP. HSAs are portable, meaning the distribution benefits stay with you even when you change jobs, drop the HDHP, or retire.
Second, by paying your medical expenses with savings outside of the HSA, you can use the HSA to pay medical expenses incurred during retirement with tax-free distributions. Health care continues to be one of the largest expenses in retirement. Let’s say that you contribute $3,500 per year to your HSA account for 20 years and earn an annual 7% return by investing in a mix of stocks and bonds. By the end of the 20 years, your HSA would be worth $143,484, and you would have saved $420 in federal tax per year ($8,400 over 20 years) assuming a 12% tax rate. You will only have put in $70,000 over the 20 years, so your money is now worth more than double! Moreover, you will have over $140,000 in a nest egg to help pay for medical expenses tax free in your golden years.
From tax-deductible contributions, to tax-free growth, to long-term investing, to tax-free distributions, to portability, the HSA provides many options and versatility for retirement planning. Be sure to give us a call if you are interested in this valuable retirement planning strategy. We are here to help.