Many companies offer health savings accounts, or HSAs, as part of their benefits packages. While HSAs can be a great tool for setting aside pretax income for medical expenses, it’s important to note some exceptions as you save for retirement or consider spending those funds.
Big Tax Benefits
An HSA, which is offered in conjunction with a high-deductible health plan (HDHP), is a tax-exempt trust or custodial account you set up to pay for or reimburse certain medical expenses you incur, according to the IRS. Contributions and distributions, if the latter is used to pay for qualified medical expenses, aren’t taxed. Plus, the funds in the HSA grow tax-free.
What some people might not realize is contributions made via payroll avoid the Federal Insurance Contributions Act (FICA) tax, says Carl Hall, the chief investment officer at Century Bank and the founder of HealthyHive.com, a Boston-based provider of HSAs and health-care cost information. That makes HSAs as “tax-perfect as it gets,” he says.
HSAs Are Underused
HSAs are rising in popularity, but they are still underutilized by most Americans, says Rob Foregger, the co-founder of NextCapital, a Chicago-based roboadviser.
So, what does it take to participate in an HSA? To be an eligible individual and qualify for an HSA, the IRS says you must meet the following requirements:
- You are covered under a high-deductible health plan (HDHP) on the first day of the month.
- You cannot be covered by any other health insurance.
- You aren’t enrolled in Medicare.
- You can’t be claimed as a dependent on someone else’s tax return.
For 2019, if you have self-only HDHP coverage, you can contribute up to $3,500. If you have family HDHP coverage, you can contribute up to $7,000.
“Most people qualify for an HSA, so long as they have a health insurance plan with an annual deductible of at least $1,350 for single coverage, or $2,700 for a family,” says Foregger. “Best of all, if you don’t use all the money you contribute in a given year, you can use the money in a future year.”
Don’t Use HSAs for Current Medical Expenses
The HSA was billed as an individual retirement arrangement or IRA for health care expenses in retirement. But many people use these accounts for current medical expenses instead of those they might incur in retirement. That’s not a bad thing, per se. It’s just that doing so defeats the purpose of using your HSA to fund health care expenses in retirement. It drains the account, leaving you with nothing to pay for those expenses.
In some cases, people with HSA accounts have no other funds to pay for current health care costs. If, however, you do plan to use your HSA to cover medical expenses in retirement, consider investing in mutual funds instead of low-yielding money market deposit accounts. Most of the top HSA providers now offer such long-term investment options.
Medicare and HSAs
Once you enroll in Medicare Part A and/or B, you can no longer contribute pretax dollars to your HSA. But you can use the accumulated funds to pay for medical expenses with no tax consequences, says Martin Trussell, the executive director of the Employers Council on Flexible Compensation.
What’s more, says Trussell, retired HSA owners may also make tax-free withdrawals to pay for medical care for a spouse or other tax dependents.
No Need to Take RMDs
You are under no obligation to use your HSA to fund current and/or future medical expenses. You could use it as a savings account to pay for non-qualified medical expenses and other costs, though you would be subject to a 10% penalty. Plus, there is no required minimum distribution (RMD) with an HSA as there is with a traditional IRA, says Hall. Owners of such IRAs are required to take an annual minimum amount, a distribution, from their accounts once they turn age 70½. HSA owners, by contrast, can have more of their money grow tax-free for a much longer period of time.
Be a Smart Shopper When Choosing
The idea behind high deductible plans is that people spend their money allocated for medical expenses wisely. But that’s not the case, says Hall. “If people really understood their power, there would be a lot more time spent on price discovery,” he says. “The data are telling: People are getting hosed at every turn.”
His advice: If able, get quotes from different vendors for services such as MRIs and other expensive medical tests and procedures. “Wasting HSA dollars on overpriced services that often occur in the radiology category can have a devastating long-term impact on the HSA’s future value,” says Hall.