Health Savings Accounts: The Ultimate Triple Tax-Advantaged Account

Updated 3/2022

Building up a savings account for a rainy day is a must when it comes to financial well-being, and this includes having enough funds to cover medical expenses. You don’t want to be in a position where you are avoiding a trip to the doctor because you don’t have the funds to pay for a visit, a hospital stay, or for medications. Unfortunately, many people do find themselves in this situation, and their health and financial well-being suffers as a consequence.

You could opt to have a regular savings account to help cover these types of expenses. But you could also opt for the HSA (Health Savings Account), which is an alternative way that you can save and invest for your medical expenses. Read on to see whether an HSA is the right move for you.

WHAT IS A HEALTH SAVINGS ACCOUNT?

A health savings account is a pre-tax account that is dedicated to paying for qualified medical expenses. Examples of qualified medical expenses include:

• Breast Pumps and Supplies
• Physical Exams
• Co-Payments and Co-Insurance
• Dental Treatment
• Vision Care (contact lenses, eyeglasses)
• Hospital Procedures
• Prescriptions

The big prerequisite to opening an HSA is that you are also enrolled in a high deductible health plan (HDHP). Those that are enrolled in other healthcare plans, such as HMO’s and PPO’s, are not qualified to open an HSA.

So before you get too excited about possible tax savings for medical expenses and the other benefits of an HSA, the primary question should be: Does it make sense to be on an HDHP? 

If you answer yes, then having an HSA is an easy choice. Go for it.

However, if it does not make sense to have an HDHP, then you can shelve the idea of opening an HSA. Don’t put yourself in a less than optimal health care plan just to have access to an HSA.

WHO SHOULD BE ON AN HDHP?

This is all about saving you money in the long run, so compare your costs of being in a more traditional plan versus an HDHP. Factors to consider:

• Monthly premiums: These will be lower for HDHP plans versus non-HDHP’s
• Annual deductible: Expect this cost to be higher for HDHP’s. The deductible is at least $1,400 for individuals and $2,800 for families in 2022.
• Annual Out of Pocket Expenses
• Co-Insurance
• Co-Pays
• Tax Bracket

You can refer to this AARP calculator to compare the costs between an HDHP and a traditional health care plan. Remember to take all costs into account when making a decision. 

If you and your family are relatively healthy and do not expect to pay much for medical care in the upcoming year, an HDHP may make sense.

However, if you or one of your family members has a chronic illness, or you will be having a major medical event (giving birth, major surgery, etc) in the upcoming year, it may make more sense to stay on a traditional plan in order to keep your overall costs low.

WHY SHOULD I EVEN BOTHER WITH AN HSA?

The reason that HSA’s have become so popular is because they offer a rare triple tax advantage.

Most savings and investment accounts will tax you at some point. Either they will tax you on the front end (when you are investing with post-tax money), or on the back end (when you withdraw the money). However, the HSA can avoid taxes all across the board! Here is how the HSA gives you a triple tax advantage:

Pre-tax: You are using pre-tax dollars to contribute to your HSA, which will then lower your taxable income.

Tax-exempt: While the money is in your account, it will remain protected from taxes. This means that any growth in the form of interest, capital gains and dividends will NOT be taxed.

Tax-free withdrawals: As long as you’re using the money for qualified medical expenses, your money will not be taxed upon withdrawal!

(A note about distributions: Once you hit age 65, you can use your HSA fund to pay for any expense, medical or non-medical. However, if the money is used for non-qualified medical expenses, then it will be taxed as income. If you were to withdraw this money prior to age 65 for non-medical expenses, then you would also be hit with a 20% penalty.)

This is an incredibly rare chance to avoid taxes along every step of the way when using the funds for eligible medical expenses.

Another great advantage is that there is no required minimum distribution (RMD). Most retirement accounts, such as a 401(k), require that you start taking distributions after a certain age, whether or not you actually need the money. With an HSA, there is no such requirement, so you have more control over when and how much you’d like to withdraw.

CONTRIBUTION LIMITS

For tax year 2022, the limits are $3,650 for individuals and $7,300 for families. If you are over age 55, the catch-up contribution is $1,000.

If your employer is contributing to your HSA (what a great employer!), then total contributions cannot exceed these limits.

Once you reach age 65 and are eligible for Medicare, you can no longer contribute to your HSA.

HOW IS THIS DIFFERENT FROM A FLEXIBLE SAVINGS ACCOUNT?

HSA’s are often confused with a similar sounding account, the Flexible Spending Account (FSA).

The health FSA is also a pre-tax savings account dedicated to paying for qualified medical expenses. However, it differs in these following ways:

• Contributions are not invested: The contributions are a set dollar amount that you pre-determine, and you cannot invest this money. The limit for tax year 2022 is $2,850, which is the same for both individuals and families.
• Contributions are traditionally use it or lose it: Prior to the pandemic, if you did not use the funds from your FSA in one calendar year, then you would lose the balance left at the end of the year. However, starting in 2020, employees were given an option to carryover their balances from the previous year. This differs depending on your employer, so you will need to check in with your employer for details that pertain to you.
• FSA’s are employer-dependent: Although employers can help contribute to an FSA or an HSA (not a requirement), and both of these accounts are typically set up through the workplace, your FSA is not portable, whereas your HSA is oortable. Meaning, if you were to leave your workplace, you cannot take your FSA with you. However, your HSA stays with you, regardless of where you work.

To make matters a little more confusing, there is another popular FSA called the dependent care FSA. This savings account is earmarked for qualified dependent care only, not medical expenses.

WHAT ARE THE DIFFERENT STRATEGIES?

There are 2 main strategies for using your HSA funds:

1. Pay as you go: As you incur medical expenses, you can simply pay for your medical expenses from your HSA. You contribute just enough to cover your medical expenses for the year.
2. Use it as a “health savings” retirement account: Due to the triple tax advantage, you can treat your HSA like a retirement account specific for medical expenses. You would invest this money, with the intent of keeping this money in the HSA long term so that once you hit age 65, you can pay for your medical expenses in retirement tax-free. As health care costs continue to rise and the future of health care is uncertain, this is not a bad idea!

If you use this second strategy, then plan to pay for your current medical expenses out-of-pocket. There is no deadline for reimbursing yourself, so you will also want to start a good record-keeping system that includes copies of bills and receipts. When you’re ready to make your withdrawals, you can show these receipts as proof.

Of course, life happens and medical emergencies may require that you dip into your HSA sooner than you had planned. The whole point is that the funds in your HSA are there for you when you need it, whether it’s for now or for later.

WHERE TO GO FROM HERE

Once you determine that an HDHP is right for you, then opening an HSA should be high on your list of priorities. Figure out your strategy, then determine a good place to open up your account. You can either open one through your employer or on your own (note: opening up your own HSA will mean that you will have to pay payroll tax, but you still get an income tax deduction). When researching your own, you will want to consider fees, ease of use, minimums, and investment options between different HSA providers. 

You should be reviewing your healthcare options annually so that you don’t miss any potential benefits! If an HSA makes sense for you and you don’t have one yet, make sure that you don’t miss this opportunity to look into opening up an account.

Do you have an HSA? What’s your particular strategy? Do you have any tips to share? Comment below!