Imagine holding an asset that enjoys the contribution benefits of a traditional IRA and the distribution benefits of a Roth IRA. What investment portfolio wouldn’t benefit from this kind of tax-efficiency? Read on to learn about the increasingly popular Health Savings Account – the only type of account that is never taxed if used properly.
What Is A Health Savings Account?
As the name suggests, a Health Savings Account (HSA) is a tax-advantaged way of setting aside money for healthcare expenses. Contributions are made by an individual (or employer) on a pre-tax basis, thus lowering one’s taxable income. That money is then available for immediate tax-free withdrawals so long as it is used for qualifying medical expenses. This makes HSAs a nifty way to cover everyday healthcare costs like doctor visits, prescriptions, or even contact lenses.
Indeed, an HSA can be a great short-term asset, but as we look at the big picture the case gets even more compelling.
HSA money never expires. On top of that, funds within an HSA can be invested to gain market exposure all while growing tax-free. That’s an especially good thing since, for most of us, the majority of our significant medical expenses will occur later in life and likely in our retirement years. A strong retirement plan considers and plans for these expected health costs anyways– often to be covered by an IRA, 401(k), or other long-term assets. Taking advantage of the flexibility and unprecedented tax-advantages of an HSA make it a powerful vehicle for any financial plan.
Restrictions On Health Savings Accounts
So what are the drawbacks?
Contributions to an HSA can only be made in years when enrolled in a High-Deductible Health Plan (HDHP) and is subject to certain deductible minimums ($1,400 for self-coverage or $2,800 for a family plan -- in 2021). The affordability of HDHP premiums amidst rising health insurance costs is one reason HSAs have gained popularity in recent years. Many employers that opt for the lower premiums of an HDHP will instead make regular contributions to the employee’s HSA account as part of their benefits package.
Limits also exist to the amount that can be contributed in each tax year ($3,600 for singles and $7,200 for those under a family plan – in 2021). Additionally, once money is contributed to an HSA account there is no going back. You have no ability to transfer out or otherwise re-characterize the funds. The account holder will pay a 20% withdrawal penalty and lose the associated tax benefit should they need to access the funds for anything other than a qualified medical expense, even financial hardship.
Example Of HSA Usage
In most cases, the flexibility and practicality of an HSA can outweigh the drawbacks. I recently heard the story of a young married couple that illustrates this well:
With a household of two working adults and no dependents, this couple was faced with a heavy tax burden when it came time to file their return. Luckily, the couple held an HSA account and HDHP through the husband’s employer. The couple made no previous contributions to the HSA aside from those made by the employer.
Rather than send their cash to Uncle Sam, the couple was able to make a contribution to their HSA (like an IRA, you are given until Tax Day to do this). The contribution was 100% deductible and thus lowered the amount of tax they owed. For a couple in the 22% tax bracket, making a $7,200 contribution to an HSA would save them $1,584 in taxes. Hoping to start a family soon, the couple can now opt to earmark their HSA funds for costs associated with having a child, or save and invest them for the long-term. Either way, they will never have to pay the $1,584 in taxes.
The old adage reminds us that death and taxes are life’s two certainties. An HSA doesn’t exempt you from either, but when properly used it absolutely can lower your tax burden while securing necessary funds to cover significant healthcare needs.
Interested in having a conversation about how an HSA could benefit your situation? Let’s sit down and talk about it. The first consultation is always free. Schedule a call with me at Guide Financial Planning today!
See IRS Publication 969 for more information about Health Savings Accounts and their tax-implications.
About Guide Financial Planning
Guide Financial Planning is led by founder Ben Wacek, who is a Christian fee-only Certified Financial Planner™ and Certified Kingdom Advisor®. He has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective using Biblical principles. Based in Minneapolis, MN, he works with clients both locally and virtually throughout the country and abroad. You can follow the links to learn more about Guide Financial Planning and our team and the services we offer.