4 Ways to Get the Most Out of Your Health Savings Account (HSA)
Even considering the outside possibility of health care reform in the U.S., health care expenses aren’t going away anytime soon. Additionally, the average person needs about two years of long term care in their lifetime. Ignoring inevitable medical costs and the potential of long term care can prove to be a major mistake in financial planning.
An often underrated solution in planning for future medical expenses is a Health Savings Account (HSA). HSAs have something that no other account type can boast: a triple tax benefit (Tax deductible contributions, tax deferred growth, and tax free withdrawals¹). However, surprisingly few people maximize the features of an HSA. In this blog, I will lay out 4 ways to get the most out of your HSA.
1) Contribute to your HSA
The maximum contribution for 2022 is $3,650 for single coverage, and $7,300 for family coverage. An additional $1,000 contribution can be made on top of those amounts once you reach age 55. Any amount you contribute to an HSA is deductible, and employers allow you to make contributions through payroll. Additionally, once in your lifetime, you’re able to make a qualified funding distribution of up to that year’s HSA contribution limit from a Traditional or Roth IRA².
Unlike IRAs, there is no income limitation to take a deduction. Also, the HSA deduction is not limited to those who itemize deductions, so even if you claim the standard deduction, you still benefit by contributing. Of course, contributions will have varying levels of advantage on any given year depending on your tax situation, but consider this scenario:
A married couple filing jointly, whose income places them in the 24% marginal tax bracket would get a $1,752 marginal tax benefit by making a maximum contribution under family coverage. Plus, in some cases, there are other added benefits that come with having a lower adjusted gross income (AGI).
2) Pay for medical expenses out-of-pocket
The vast majority of people use an HSA like a turnstile. Money goes in and then comes right back out to pay for medical expenses. If your budget requires the cash flow, the turnstile way of using an HSA is still a great benefit. However, if you’re able to contribute to an HSA and pay for medical expenses out-of-pocket, a new world of HSA features is opened up.
Paying for medical expenses out-of-pocket could potentially increase your itemized deductions. That’s right! Not only can you get a deduction for making the HSA contribution, you can get another deduction for paying for medical expenses out of your cash flow. Granted, not everyone benefits from itemizing deductions, and your medical expenses need to equal at least 7.5% of your AGI to start itemizing them. However, there’s many people who could take advantage of itemizing through “bunching” deductions. For example, you can “bunch” multiple years worth of property tax payments, charitable contributions, and planned medical expenses into one tax year. Then in the next tax year you’re left with more free cash flow, and you can take advantage of the relatively high standard deduction that’s available currently.
3) Invest your HSA
If you are leaving funds in your HSA, that opens up the opportunity to invest in ETFs and Mutual Funds. Beyond the natural benefit of receiving compounding returns by investing, you can maximize the triple tax benefit. For example, assuming a 7% annual return, a maximum contribution under family coverage for 20 years would get you to an account value of $300,000. Under that scenario, not only did you get a deduction for the $146,000 you put into the account, you will pay no tax on the full account value of $300,000 upon withdrawal for qualified medical expenses. That’s the equivalent of $154,000 more tax free dollars.
4) Use your HSA in retirement for whatever you want
In retirement, HSA distributions remain tax free for qualified medical expenses, including things like medicare premiums. The average couple retiring at 65 can expect to spend $315,000 on medical costs in retirement, according to a study by Fidelity Investments³. It’s easy to see how an HSA will be easily spent in retirement just for medical costs. However, you can reimburse yourself for past medical expenses that were paid out-of-pocket and weren’t itemized as a deduction. This is why I recommend keeping receipts/records of all your medical bills. That way, if you ever want to create tax free income for a large unexpected expense, you have documentation available to validate your reimbursement.
I’m often asked, “What if I need to use my HSA funds for something other than medical expenses?” Another attractive feature of HSAs is the ability to use them like a Traditional IRA once you’re 65. You can take distributions for any reason starting at age 65. You will owe ordinary income tax on those withdrawals, but it’s still a tax saving if you are in a lower tax bracket at the time of distribution than when you made your original contribution.
There’s No One-Size-Fits-All
Just like everything else with personal finance, there’s no one-size-fits-all. HSAs aren’t available for everyone, and even if they are, they may not be the right account for you. Even more so, those who have HSAs aren’t always in a place to maximize their benefits. At Redeem Wealth, we believe there shouldn’t be judgment in where you’re at with your finances today. We do believe that taking steps to better align your money with what you value most will lead to more fulfillment and a bigger impact. If you want to talk to a financial planner about how to use an HSA in a way that makes the most sense for you, please feel free to reach out to us.
¹ Tax free distributions are limited to distributions for qualified medical expenses.
² For more information on HSA rules, see IRS Publication 969.
³ Here’s How Much You Can Expect to Spend on Healthcare in Retirement. (Barron's)
