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Health Savings Accounts: A Hidden Gem

Published -
November 6, 2022

The topic of regrets recently came up in a conversation and my first thought (no surprise, it was financial) was that I wish I had started a Health Savings Account (HSA) back in 2003 when they first came out. Luckily, I did eventually open one, but I didn’t do enough homework to learn of the many benefits of this tax saving device. Had I known then what I know now, I would have treated my HSA very differently.

Most of us around my age viewed HSAs as something a little better than the Flexible Spending Accounts (FSA) we had for many years prior. I also didn’t have any interest in moving to a high deductible health insurance plan. Who wants a high deductible? It took me a few years to realize the HSA was far superior to the spending account and also better than the 401k I was diligently maxing out.

The Basics

Individuals and families who are covered by a high deductible health plan (HDHP) can contribute up to $3,650 or $7,300 (for 2022), respectively, into a HSAs. After age 55, they can add an additional $1,000 as a catch-up contribution. Once someone is enrolled in Medicare, they are no longer eligible to contribute but the HSA plan can stay with them for life.

For those working for a company that offers an HSA and an FSA, you cannot do both. The HSA is far superior so just drop the FSA.

Why HSAs are so Awesome

  1. Triple Tax Benefit
  2. When you contribute to an HSA, you are able to deduct your contributions from your federal income tax and unless you live in California or New Jersey, they are deductible at the state level too. This is similar to an IRA contribution without the income restrictions.
  3. You can invest the proceeds inside of your HSA and the growth is tax-free. To get the most benefit out of this feature, the investments you select should be geared toward long-term growth. We usually recommend a target fund that corresponds to age 70.
  4. When you withdraw the funds from the HSA later for qualified health expenses, there is no tax owed. Compare this to the IRA where you are taxed on withdrawals at your marginal tax rate. In this case, HSA wins.
  5. Many employers will make contributions to your HSA on your behalf.
  6. Even if you open your HSA at work, it belongs to you, and you can take it with you when you leave.
  7. You can save receipts for medical expenses you pay out-of-pocket and submit them years later for reimbursement. As long as you can afford to pay your health expenses out of your cash flow, this is a great tax strategy to let your HSA grow.

Other Lesser-Known HSA Strategies

Adult Children  

There are specific criteria that must be met for this to work and the window is narrow, but for those who can do this, it’s a neat little trick. This technique is for young adults, no longer claimed as a dependent child but covered by their parent’s high deductible health plan. If the adult child meets these criteria, they can fully fund their own HSA up to a family contribution level. Parents or grandparents can help with the funding by making a gift but the child who is the HSA owner would receive the tax deduction on the contribution.

Catch-up Contributions for Your Spouse

When you turn 55, you are able to contribute an additional $1,000 to your HSA as a “catch-up contribution.” When your spouse turns 55, they are also able to do a catch-up contribution, but it needs to be to a different HSA. Opening an additional HSA may seem like extra work but the benefits of this are well worth it.  When selecting a second HSA, look for one that allows you to invest every dollar in the HSA.  Some plans require you to keep a level of cash to meet any distribution needs.

The over 59 ½ IRA to HSA Switcheroo

For those individuals with large IRA balances who are over the age of 59 ½, they can take a distribution (up to the HSA contribution limit) from their IRA and deposit the proceeds into their HSA. The net affect for tax purposes is that the tax on the IRA withdrawal is netted out from the deduction of the HSA contribution—no taxes owed.

The reason we look at someone with a “large” balance (yes, this can be subjective) is we see so many individuals cursing the Required Minimum Distributions when they are in their 70s. Often these people do not need the money and are forced to take it and pay the tax. Strategies to lower the IRA balance in a tax-friendly way can be advantageous.  Nothing more tax-friendly than moving it from fully taxable to non-taxable without paying tax or a fee.

If you were planning on making the HSA contribution outright, just invest those dollars into a taxable investment account.

Being constrained by the HSA contribution limits may make this strategy seem insignificant but doing this strategy from age 59 ½ to age 65 could mean moving over $50,000 (for a married couple) from an account that will cause tax pain to an account with no tax pain. If someone were to keep working and are covered by their employer’s health plan, this could be stretched even longer. This plan also shifts the future growth of every dollar moved to the tax-friendly account, so the benefit is much more than the initial transfer. Not insignificant when you consider how simple this is.

Don’t confuse this with the once-in-a-lifetime IRA to HSA Rollover, aka “Qualified HSA Funding Distribution.” This rollover is something that can be done by an individual regardless of age, but this is not a strategy we’ve ever recommended.

Spending Down Your HSA

Health care becomes one of our largest expenses later in life so there will be plenty of opportunities to spend your HSA dollars. What you may face, however, is a decision on when to start pulling out funds vs letting the account grow. One thing experts agree on is that spending down your HSA is much better than passing it on to beneficiaries (other than your spouse). If you leave your HSA to your children, they will be taxed on the balance. Luckily your survivors have twelve months after your death to submit health expenses for tax-free distributions.  Make sure everyone knows where your stash of old medical receipts are hidden!

Key Points

  • Max out your HSA contributions.
  • Invest the balance for growth.
  • Don’t use the account for health reimbursement until after you are retired.
  • Save all your medical receipts. We recommend scanning them to keep electronically as well as holding the paper file.

There is no other saving or investing instrument that offers the tax-savings benefits of the HSA. As with most financial planning strategies, the earlier you start, the greater the benefit. And, just like most strategies, everyone’s situation is different so consulting with a qualified financial advisor is always a good idea.

How can we help you?

We’re happy to answer any questions you may have about financial, retirement or tax planning. We also love to talk about investment management and how our process increases the odds of our clients meeting or exceeding their goals.

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