In our last post, we discussed the dilemma of health insurance in the US, and what we opted to do as we transitioned away from our Medi-Share service to a traditional healthcare plan from the ACA marketplace.
We got a high (VERY high) deductible Bronze-level plan, and I left you in suspense at the end of that post stating that one of the biggest reasons we did so was that it qualified us for an HSA or Health Savings Account. I even mentioned how such an account might be the solution to remedying the ever-increasing healthcare costs that appears to be on the horizon.
I’ll even take it one step further and say that the HSA just might be the single greatest investment account ever.
I know those are big words. I hope I’ve got your attention.
Triple Tax Advantage
An HSA in its most fundamental form is an account where we can save to pay for medical expenses. But the incentive to use it comes in the form of special tax-treatment. It’s often described as a triple tax advantage:
- No tax putting it in – You can deposit money into this account pre-income tax. (If your employer offers you an HSA and you can deposit via payroll deduction, not only can you avoid federal and state income tax but also the FICA payroll taxes as well.)
- No tax on growth – The money in the account can be invested to grow tax-free from year to year. (Meaning you don’t have to pay taxes on dividends or capital gains.)
- No tax taking it out – The money can be withdrawn to pay for qualified medical expenses without incurring any tax.
So to put it simply, this is the most tax-advantaged account currently known to man. There are annual deposit limits, which are $3350 for an individual and $6750 for a family in 2016. (Catch-up contributions are also allowed if you are 55 or older.)
For Health Expenses
HSAs are flexible in that the money can be used not only for the primary account holder but for any of his dependents as well. So in other words, the funds can be shared with the family for qualified medical expenses. If you’re curious what those include, check out this link here—it’s fairly broad.
For example, if you put $2000 in your HSA, that amount is decreased from your taxable income for the year. Then if your child needs eyeglasses that cost $200, you can use the funds from this account to pay for it. No taxes.
Now one of the interesting things about HSAs is that you do not need to withdraw the funds to pay for your medical expenses at the time of payment. You can keep your receipts to be reimbursed from your account at a later date—even years down the road. This unique allowance creates an incredible opportunity for the enterprising Crumb Saver.
You see, the funds that aren’t used within your HSA can be invested. That means, like an IRA, you can allocate those funds to investments that will grow over time—tax-free. This is great for young people who can save up now while they have few health expenses to allow that money time to grow for when they are older with more medical expenses.
But that’s not all, since you can defer your reimbursement to a later date, you can offset your tax-free withdrawal to a time when you really need it. So say you’re able to pay for your child’s $200 glasses out-of-pocket this year without touching your HSA, you can let that money grow undisturbed then submit your receipt later when you actually need the money. This extra uninterrupted time allows compound interest to work its magic.
HSAs: Pre and Post 65
Now you may be wondering, what happens if I end up having a bunch of money in my HSA that I never use? What happens then?
Once you turn 65, the rules for HSA withdrawals loosen greatly. The funds in that account can still be withdrawn tax-free for medical expenses, which then (significantly!) also includes premiums for Medicare. Prior to 65, HSA funds cannot be used to pay for insurance premiums. On top of that, you can also withdraw funds for ANY PURPOSE and will only have to pay income tax on it. Prior to 65, if you withdraw funds for reasons other than qualified medical expenses, you not only pay income tax on the amount but also a 20% withdrawal penalty. Ouch!
In other words, the HSA turns into the equivalent of a Traditional IRA once you hit 65. No wonder the Mad Fientist calls it the “Ultimate Retirement Account”. (Check out his post for a more thorough explanation.)
Summing Up the HSA
So let’s just quickly recap the major features of the HSA:
- Ability to deposit money pre-tax.
- Allows for money to be invested tax-free.
- Allows money to be withdrawn for qualifying medical expenses tax-free.
- Funds can be applied not only to your own medical expenses, but your dependents’ as well.
- Reimbursements for medical expenses can be deferred to a later time with appropriate receipts.
- Withdrawals for non-qualified medical expenses prior to age 65 will trigger income taxes and a 20% penalty.
- Prior to age 65, insurance premiums are NOT qualified medical expenses, but after 65 Medicare premiums ARE qualified medical expenses thus being eligible to be funded by HSA funds tax-free.
- Upon turning 65, an HSA effectively turns into a Traditional IRA where money can be withdrawn for reasons other than medical by incurring only income tax.
- You can contribute to your HSA only when enrolled in an HDHP, but you don’t have to be enrolled in an HDHP when you want to withdraw.
The HDHP Catch
The biggest downside is that you qualify for an HSA only if you have a HDHP (high-deductible health plan) insurance plan. Just like the name suggests, this is a health insurance policy that has a high deductible. These types of healthcare plans aren’t right for everyone, and so not everyone qualifies for HSAs. The reasoning, I think, is that people with HDHPs are the ones that need assistance in saving up to meet their sky-high deductible.
Two Ways to Look at the HSA
If you are interested in opening an HSA, there are two general ways to look at this account. One is to treat it like a medical emergency fund. It’s savings to meet the health insurance deductible and other associate medical costs, so the money should be protected and kept safe as far as possible. The second is to treat it like a retirement account, where you let the money compound with as few disturbances as possible. In this second case, you would take more risk with the money and invest it in more volatile assets.
What We’re Doing With Our HSA
Like we mentioned in our last post, one of the main reasons we were OK with getting a health insurance plan with such a high deductible was because it qualifies us for an HSA. We anticipate that health insurance premiums and/or deductibles will continue to go up, and so we can pre-empt that increase by starting to save up in a tax-savvy way to help meet those deductibles. We do currently have an emergency fund that offers us a cushion were we to run into unforeseen medical needs now, but we plan to supplement that by stocking up our HSA.
So we are viewing our HSA as primarily a savings vehicle where we are stashing cash without taking massive risk with it. Once we save up an adequate amount to meet our insurance deductible, the remaining amount will be invested for higher potential growth (i.e in riskier assets).
We opened an HSA with a company called Health Savings Administrators. They have the clearest explanations on their website about their fees and how they operate compared to some of the other services I looked at. But above all, I selected them because they offer Vanguard index funds as investment choices. Most other HSAs don’t offer Vanguard funds and those who do require you to go through other brokers which often comes with an additional layer of cost.
Are HSAs for You?
Is this account for you? While I do think that the HSA is a splendid idea that incentivizes consumers not only to save but to also be more mindful of their medical spending, it may not be for everyone. It may not make sense for you to give up a good health insurance plan just to qualify for an HSA right now (or it just might not be possible for you to qualify anyway). You may have other tax-advantaged ways to save and invest your money without opening yet another account. You may be getting out of debt and aren’t ready to get investing just yet. The list can go on. But as with all things, never invest in something you don’t understand and that goes for HSAs too.
Have YOU had experience with HSAs? Share your thoughts with us below!