Health Savings Accounts (HSAs) are a savings/investment vehicle that allow you to set aside money on a pre-tax basis to pay for qualified medical expenses. By using untaxed dollars to pay for deductibles, copayments, coinsurance, and some other expenses, HSAs have become increasingly popular due to the tremendous flexibility to pay for medical expenses, now and in retirement.
Establishing and Contributing to an HSA
To establish an HSA, you must have qualifying health coverage under a high deductible health plan (HDHP). An HDHP has an annual deductible of at least $1,500 for individual coverage or $3,000 for family coverage. These plans also have a maximum annual out-of-pocket expense of $7,500 (individual) and $15,000 (family). Additionally, you must not have any other health coverage (with a few exceptions) and cannot be enrolled in Medicare to contribute to an HSA.
One of the best features of an HSA is that there are no income limitations for making contributions, unlike Individual Retirement Accounts (IRAs). This means any individual who is eligible for an HSA under the aforementioned criteria is able to contribute the full amount each year ($3,850 for an individual or $7,750 if you have family coverage through an HSA in 2023). These contribution limits are higher for individuals over age 55.
The Potential Benefits of an HSA
Once you establish and start contributing to an HSA, how should you use the account balance each year? Ideally, funds in an HSA are best left in the account to grow, and we recommend that they are not used for small or routine medical expenses. This allows the account to benefit from tax-deferred (and potentially tax-free) growth over time.
For example, if an individual were to contribute the annual maximum to an HSA (currently $3,850) for 10 years, they would have a total of $38,500. Each year their taxable income is reduced by the contribution amount; this is the most immediate benefit of an HSA. If those contributions stay invested the entire 10 years, and the account experiences an 8% average growth rate, the account value could be greater than $60,000 at the end of 10 years: a 56% increase! After another 10 years of growth, the account value would more than double. After a total of 30 years, the account value could exceed $280,000. This is not a trivial amount since healthcare is one of the highest expenses in retirement. The average cost of healthcare in retirement for a couple is approximately $315,000 according to a 2022 Fidelity study.
Wouldn’t it be great to fund your healthcare expenses in retirement with tax-free money, while allowing your other assets to remain invested for future growth? The key takeaway here is that making regular contributions, and investing them appropriately and as early as possible, is important to maximize the growth potential of an HSA, as it is with any other type of investment.
How to Use an HSA
Let’s assume you followed the strategy above, and now have a substantial balance in your HSA. How can you use those funds? There is a long list, but any medical expenses that would typically qualify for a medical deduction on your tax return are eligible expenses. You can also use HSA funds to pay for long-term care insurance premiums and Medicare premiums, once you reach age 65. It is worth noting that any expenses paid for with funds from an HSA cannot also be claimed as a medical deduction on a tax return.
What if you don’t need the entire account balance to pay for medical expenses, or other qualified expenses? If you are fortunate enough to maintain good health throughout your entire lifetime, and don’t foresee using the entire account value for qualified medical expenses, you have other options. Once you reach age 65, you can withdraw funds for non-qualified expenses similar to an IRA; you pay regular income taxes on the distribution amount, but you avoid the 20% tax penalty you would incur otherwise. Additionally, if you kept records of your out-of-pocket medical expenses (paid during previous years), you can use the HSA to reimburse yourself for those expenses, as long as the HSA was established at the time those expenses were incurred.
Guiding You Forward
At Pathfinder Wealth Consulting, our comprehensive financial planning and wealth management services help clients make decisions to optimize their entire financial life, including HSAs. Our team of CERTIFIED FINANCIAL PLANNER™ Professionals assist our clients in determining whether their health coverage qualifies them to make contributions to an HSA. We review their HSA investment options to make sure the funds in each account are appropriately allocated for both short-term and long-term use, along with determining the proper timing of using funds. Additionally, as part of our annual planning, we can also generate tax projections to determine the impact of withdrawals from retirement accounts and other investments to ensure the distribution strategy is as tax efficient as possible.
Making the right decisions with your HSA funds is key to ensuring you maximize the tax, and other, benefits of the account over the lifetime of your financial plan. If you need help determining whether you are eligible to contribute to an HSA, how much to contribute, and how to invest in the account in a way that compliments your long-term financial plan, please visit our website, or give us a call at 910-793-0616. We are here to guide you forward.
Commonwealth Financial Network® and Pathfinder Wealth Consulting does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.