Law #24: Save pre-tax dollars for health expenses with an HSA
The Law
Saving money is a huge win. Saving money tax-free is like a double win. Tax-free savings accounts allow you to put money to the side from earnings before payroll taxes are deducted. Funds in these accounts are usually invested and earn a return, often also tax-free. There are several tax-free ways to save money; one great vehicle is a health savings account (HSA). Learn how to leverage an HSA for tremendous savings, investment, health, and retirement benefits.
Your Keys to Power
First, what is a health savings account? Abbreviated HSA, a health savings account is a feature of man health insurance plans for individuals and employees. To help reduce the financial impact of insurance, deductibles, and medical expenses, the federal government permits a tax-favored savings account that allows insurance holders or employers (or both) to place pre-tax dollars into savings that can later be withdrawn to pay for eligible out-of-pocket healthcare costs.
Who qualifies for a health savings account? You must have a high deductible health plan (HDHP) to qualify for an HSA. Go here to review more details about what insurance plans entitle the holder to secure an HSA.
And now, for your options to benefit from HSAs.
A rainy-day fund. HSAs are excellent vehicles for saving money tax-free that you can later use to reimburse eligible healthcare expenses. You’ll need to prove that you’ve spent money on healthcare costs, but that’s as simple as holding onto your receipts. You can make withdrawals for reimbursements whenever you need the cash, even years or decades after you’ve spent the money. Unlike withdrawing from an individual retirement account, your eligible withdrawals from an HSA will be tax-free. Based on these attributes, HSAs serve as a quite nifty rainy day fund in a few ways.
First of all, saving money pre-tax means you’re reducing your payroll tax expenses.
Secondly, as a traditional rainy day fund, these funds will be available if you run into unexpected healthcare expenses.
A third, perhaps even more exciting feature is the ability to save pre-tax money that has the opportunity to grow. Because HSA accounts funds can be invested, you can earn returns on your savings. If you can afford to pay for current-day medical expenses from disposable income rather than from your HSA account, you could leave your HSA funds invested to continue growing. Remember, you can always withdraw funds from your HSA to reimburse you for covered expenses whenever you want to in the future. By delaying withdrawals from your HSA, you run the delightful risk of your balance growing, offering a higher balance later.
As supplemental retirement account. An HSA can be great for retirement. When you reach age 65, you can withdraw from your HSA for non-medical expenses without a penalty. You’ll pay taxes on non-medical expense withdrawals at your ordinary income tax rate. Remember, if you have receipts for qualifying medical purchases, you can withdraw the money tax-free for those expenses, even if you purchased them years in advance.
Save with and for your children. Current law permits children to save with HSAs if they remain on their parents’ high deductible health plan. Children can typically stay on a parent’s insurance plan until age 26. So a 22-year-old, for instance, could open their own HSA and fund it to the maximum amount allowed by law completely tax-free. The child doesn’t have to use their own money, and the funds can be paid by someone else. One important stipulation is that the child cannot be claimed on their parents’ income tax returns.
Practical Application
Don’t run from financial savviness. We get it. These kinds of conversations may be challenging (or even boring!). Do you know what’s worse? Being broke. Even if this strategy sounds complex, do everything you can to understand how to leverage tax-free savings to your benefit. The people around you who seem to be getting ahead aren’t doing it solely by making more money than you—sure, more money helps, but sometimes, people who make less than you are doing better. Those people are using what they have in more strategic ways. Be the one who uses money wisely and impresses friends with your financial savviness. Do the work it takes to understand strategies like this, even if it requires you to seek advice from mentors and professional advisors like a CPA.
HSAs are portable. Individuals own HSA, not employers or insurers, so you can shop around. HSA providers typically charge monthly maintenance fees and may charge per-transaction fees. You can move your HSA to another sponsor if the costs are too high. Your employer may offer an HSA, but you can also choose one of your own with a brokerage firm or bank if you’re eligible.
Contribute the maximum if you can afford it. For 2023, the maximum contributions for HSAs will increase to $3,840 for individuals (up from $3,650 in 2022) and $7,750 for families (up from $7,300 in 2022). Your contribution to an HSA does not have to equal your insurance’s deductible.
Track your investment growth and play the long game. Unused HSA dollars can be invested and grow tax-free. Get tax breaks that are better than those for IRAs and 401(k)s by playing this 4-part long-game:
Save money tax-free.
Allow the money to be invested for tax-free growth.
Withdraw funds to reimburse eligible health expenses without any taxes or penalties.
Leave as many HSA funds in the account as possible to allow them to compound for years. Maximize this strategy by paying for covered healthcare expenses from your disposable income, leaving your HSA funds to compound to realize greater growth, remembering that any reimbursements you skip can always be withdrawn years later whenever you need the money, as long as you keep receipts.
Some insurance plans don’t qualify for an HSA; sometimes, that's better. Even with the potentially massive benefits of an HSA, meeting an HDHP’s high deductible can be challenging if you have significant medical expenses. Weigh your decision based on your current health to determine if an HDHP + HSA suits you. If you do not have a qualifying HDHP, you may be in a situation where your health insurance gives you such great benefits that an HSA is less attractive. Explore all your options, and if you are unsure what makes the most sense for you, ask questions to the right individuals. Speak with your benefits coordinator if you are an employee securing insurance through your employer. If you are purchasing insurance directly or setting up a group plan, consult with an insurance agency or a qualified broker.
Catch up if you’re older. If you’re 55 years of age or more, you can put an extra $1,000 per year into an HSA. Take advantage of every single dollar of tax-free savings you can afford. The money is still yours—you’ve just saved it in a different account for a specific purpose. You will likely have qualifying medical expenses at some point in your future, and it is much better to pay for those expenses with tax-free money in most cases.
Check if your employer will contribute to your HSA. Employers who offer HSAs may choose to contribute to them, often structured as matching programs.
Authority
“The bottom line is that most people are leaving money on the table if they don’t choose an HSA.” - Roy Ramthun, HSA specialist who led the Treasury Department’s implementation of HSAs after 2003 congressional approval
“I almost don’t think of them as health savings accounts, but profoundly tax-beneficial retirement accounts.” “I think [people] often don’t realize just how broad the list of things you can be reimbursed for is.” - Andy Baxley, certified financial planner
“An HSA is a no-brainer for almost everyone who has access to one.” - Carolyn McClanahan, medical doctor and certified financial planner
Our Vote
I don’t currently invest in an HSA, however, I plan to start. I do take full advantage of other tax-free savings options. Any tax-free savings option is at least worth a conversation because it means reducing outgoing payroll taxes and increasing savings. There’s no better win-win than that. I’ll kickstart my investment in an HSA in 2023, and I’m researching the best HSA options for my situation now. I plan to use the account for retirement, as I’m young and healthy enough not to need expensive medical care and can afford to pay for current-day medical expenses from monthly earnings while saving the maximum allowed in an HSA.
Reversal
There’s no reversal to the law of exploring ways to save pre-tax dollars, but if you do not have a qualifying health insurance plan, you won’t be able to avail yourself of the benefit of an HSA.
If you do qualify for an HSA, attempt to treat the account like an investment account, but only if you can afford to. To treat it like an investment account, you’d pay for your current-day medical expenses from your current income while still saving as much as you can in an HSA. If you can’t afford to pay for current medical expenses out of available cash, don’t stretch yourself too thinly. Instead, use the funds in your HSA.