I used to think that taxes were the most complicated thing in our country. That was until I tried to comprehend the bill from my recent ER visit. I had to get four stitches in my leg…simple, right? The bill was ten pages and had about 25 line items on it! I’m glad I didn’t blow my nose, because it probably would have been another $40 for a “Sterilized Nasal Discharge Receptacle”. Thankfully, I had money saved in a Health Savings Account (HSA) that covered the majority of my bill. That’s what I am going to focus on today. I can’t explain half of the healthcare laws in our country, but I can help you understand these accounts.
HSA’s are used in conjunction with High Deductible Health Plans. These plans have deductibles of at least $1,300 for individuals and $2,600 for families. The main benefit of these plans is that the premiums are lower and you can use tax-free money through your HSA to pay for medical expenses. More and more employers are switching to these plans because of the lower cost.
HSA's have two major benefits for tax purposes. First, HSA contributions are deductible in the current year from ordinary income. The deductible amount in 2017 is $3,400 for individuals and $6,750 for families with a $1,000 catch up amount for age 55 or older. If your employer contributes to your HSA, the deduction must be reduced by any amount contributed by the employer.
Example: You participate in a High Deductible Plan through work for your family. Your company contributes $500 to your HSA during the year and you contribute $3,000. You would be able to deduct $3,000 on your tax return. If you contributed the maximum of $6,750 for the year, your deduction would be limited to $6,250 because of the employer contribution.
The second benefit is that the money can be withdrawn tax free in the future if used for qualified medical expenses. Here is where the extra planning comes into play. Most HSA’s allow you to invest in stock or bond mutual funds in the account. If you invest in your HSA, it will grow tax-free as long as it is used on medical expenses when it is withdrawn. In a way, HSA's have the current tax benefit of a traditional IRA, but the future benefit of a Roth IRA if used for medical expenses. Also, you don’t have to be enrolled in a High Deductible Plan when you use the money, it only matters when you contribute to the HSA.
Example: The $3,500 that was contributed to your HSA can be invested in the account. Let’s say the money is invested for the next 20 years. The investment in the account can continue to grow tax free. The investment then grows to $15,000 in the future. You would be able to withdraw that money tax free if it is used for qualified medical expenses.
The double tax benefit that I described above is the main reason to use an HSA to supplement retirement savings. Another benefit is for individuals/couples who have 401(k) plans, or other employer sponsored retirement plans, but make too much money to contribute to a Traditional or Roth IRA. HSA's allow them to put additional retirement savings in a tax-sheltered account instead of a taxable account or non-deductible IRA.
As you can see, HSA’s can be beneficial for both tax savings and retirement planning. Six figure healthcare costs in retirement are a reality right now. HSA investments can be used to reduce the burden that you will incur later in life. Try to contribute enough each year to cover your maximum deductible. With all that being said, I always advise people not to invest in your HSA if you expect to need the money for medical expenses within the next five years. The last thing you want to do is have your investments drop in value right when you need to withdraw the money.
Healthcare is always changing so these benefits may not last forever. If you can maximize your HSA contributions, it will significantly impact your long term financial plan. If you participate in one of these plans, make sure you understand how to maximize your savings based on your current financial position. If you don’t participate in one of these plans right now, bravo for reading this entire post that has little to no impact on your life! Hopefully, you will be better informed if you switch to one of these plans in the future.
Mike Zeiter, CPA/PFS