The Holy Grail is often described as a cup with miraculous powers that provides happiness, eternal youth, or infinite abundance. And although what I am about to share with you will not offer miraculous powers (though I wish), it does offer you something equally as elusive in the form of tax-deductible contributions, tax-deductible growth, and qualified tax-free distributions; essentially, a one-stop solution that offers investors the ability never to pay taxes on dollars contributed, earned, or distributed.
Just as the Holy Grail has become a legend, so has this financial solution, which offers you compelling tax advantages. A Health Savings Account (HSA) offers just that. And if you meet the qualifications to contribute to one, you can also be a beneficiary of one of the most powerful retirement planning solutions out there.
What is an HSA?
Many things are uncertain about the future, but virtually all of us will experience medical costs. An HSA is a tax-advantaged savings vehicle that allows you to pay for medical expenses tax-free now or in the future. It can also be thought of as an improved version of a Flexible Spending Account (FSA).
Do I Qualify?
To qualify to contribute to an HSA fully you must:
- Be enrolled in an HSA-eligible High Deductible Health Plan (HDHP) either through your employer, an independent insurance agent, Healthcare.gov, or direct with the insurer no later than December 1st of the current tax year.
- You must also remain enrolled during the IRS’s 13-month testing period.
- You cannot be enrolled in any other non-HDHP health plan (including Medicare).
- It cannot be claimed as a dependent on anyone else’s tax return.
Is my Health Insurance Considered an HDHP?
Although given the parameters below, it may appear that your plan qualifies as an HDHP, it is always best to verify this with either your employer or the person issuing the policy to ensure the plan is HSA eligible.
| Item | Deductible | Max Out-of-Pocket | Max HSA Contribution Amount | Age 55+ HSA Contribution Limit |
| Individual Coverage | $1,400 | $6,900 | $3,550 | $4,550 |
| Family Coverage | $2,800 | $13,800 | $7,100 | $8,100 |
*Plan must also include no insurance coverage until the deductible is met, except for preventative care, dental expenses, and/or vision expenses.
What are the Advantages and Disadvantages of an HSA?
HSA Advantages:
- The HSA Triple Tax Advantage:
- Contributions are pre-tax, leaving you with more spendable income
- Earnings grow tax-free
- Withdrawals for qualified medical expenses are tax-free
- Allows for an accumulation of savings to pay for rising healthcare costs in retirement (balance can be rolled over each year). For a 65-year-old couple retiring today, they can expect to pay $285k in healthcare costs throughout retirement
- Ability to invest accumulated savings in Stocks, Bonds, and Mutual funds, subject to provider restrictions
- Anyone can contribute to your HSA (Employer, spouse, family member, etc.…)
- Can use funds to pay for the qualified medical expenses of you, your spouse, or any dependents listed on your tax return
- After age 65, withdrawals not used for qualified medical expenses have not been assessed a penalty, only subject to tax. (Similar to IRA)
- No Required Minimum Distributions (RMD)
HSA Disadvantages:
- Record keeping
Must keep receipts or proof of payment to substantiate that funds were used for qualified medical expenses - Fees
HSA account sometimes charge monthly maintenance fees or per-transaction fees but may be waived depending on the custodian - Penalties
Funds used before age 65 for non-qualified expenses are subject to a 10% penalty in addition to Federal and State taxes.
How do I establish an HSA?
If you are enrolled in an HSA qualified HDHP through your employer, an employer-provided HSA is likely a benefit they offer as well. Like a 401(k), contributions can be taken directly from payroll on a pre-tax basis and contributed to the account on your behalf.
If you are not enrolled in an HSA qualified HDHP through your employer, most major banks offer an HSA solution. Unlike an employer-sponsored HSA, you will not be able to make pre-tax contributions through payroll. Rather, you will need to contribute with after-tax dollars and file the appropriate documentation at tax time to receive the pre-tax contribution benefit. As with all financial solutions, ensure you perform your due diligence.
Financial Planning Considerations:
Do Not Let the Tax Tail Wag the Investment Dog
HDHP’s, a qualification for HSA eligibility, are better suited for healthy individuals who have the ability to use their insurance as a catastrophic means of protection. Suppose you find that you are consistently maxing out your Deductible under an a’ better’ plan. Out of Pocket Maximums, it may not be wise to move to an HDHP to access the HSA. With that being said, taking a pencil to paper to see if such a move would be beneficial by performing a break-even analysis between the increased costs of an HDHP plan and the amount you could put away might be extremely worth it.
Look at a HSA as an Additional Retirement Savings Vehicle
If able, paying current medical expenses out of pocket will allow HSA assets to grow to meet the needs of the rising medical costs in retirement. If no medical costs are present in retirement (yeah, right), you have the ability to withdrawal penalty-free for non-qualified expenses after age 65 without penalty to fund your retirement.
Increased Tax-Free Liquidity
If medical expenses have occurred after you established your HSA, you can submit these expenses for reimbursement at any time in the future. You will need to substantiate payment, so make sure you keep receipts! This advantage becomes more beneficial if you decide to treat this as a retirement vehicle, acting as an added tax-free liquidity source if emergencies arise.
Flexible Retirement Income
An HSA also gets the added benefit of having no Required Minimum Distributions (RMD), allowing you to be more flexible with income in retirement when compared to an IRA or 401(k) that still require RMD’s. This may equate to lower overall tax liability and less of your social security wages being subject to tax.
Estate Planning
An HSA can pass outside of a will (and probate) via beneficiary designations. After the death of an account owner, the spouse can treat the HSA as their own. However, if a non-spouse beneficiary is designated, the entire account balance is subject to taxes. If a non-spouse beneficiary is needed, it may be wise to choose someone in a low tax bracket.
Invest, Invest, Invest!
Most HSA solutions allow you to invest your balance above a certain threshold. The odds of the account growing to meet your medical needs in retirement areas are enhanced by investing your balance. For the individuals who choose not to, or can’t, take a long-term approach to the HSA, it may be wise to avoid investing together. Investing means there is a risk of loss, and if you need those dollars now, it is best to keep them safe.
An HSA is a powerful tool, A solution that offers this type of tax advantage is rare. However, tax laws are always subject to change, and while these strategies may work today, it is possible that changes could make the HSA a less favorable solution in the future.
While the use of an HSA is favorable today, it can become quite complicated when determining eligibility, establishing the account, investing, and incorporating it into your other retirement planning solutions. Our Greenspring Team is here to help you navigate these complexities, so give us a call at 443-564-4600 and speak to me or one of our many CFP® professionals on the private client or participant advisor teams.
