Why Health Savings Accounts Are a Great Tax Savings Strategy
Many clients wonder if a Health Savings Account (HSA), and the high-deductible health plan that comes with it, is right for them. It can be a great wealth-building tool, and for those who are generally healthy and don’t have many healthcare needs, it makes a lot of sense to utilize an HSA.
For those that aren’t familiar, an HSA is a tax-advantaged medical savings account that you can contribute to and withdraw from tax-free for qualified medical expenses. Funds in an HSA are split into a liquid cash account and an investment account. HSAs are not only a way to save for future healthcare expenses, but to also gain tax savings!
In fact, when used well, HSAs are a triple threat for tax savings.
First, interest and investment earnings on HSA contributions can grow tax-free. This is why many people choose to not spend the money in their HSA and let the funds build instead. For those who are healthy and don’t utilize healthcare often, an excellent wealth-building strategy is to pay for their few and infrequent medical expenses out of pocket and leave their HSA untouched. Another reason to let your HSA grow, no matter your healthcare usage, is that HSAs can lower your taxable income.
The second tax-saving benefit of having an HSA is that HSA contributions can be invested and grow tax-free. If you have an HSA, you can grow your funds through interest, and in some cases, you can also invest your contributions. Best of all? Neither interest nor investment is subject to taxes. Just like many other investments, it’s wise to leave it untouched so it can grow as much as possible. Unlike some investments though, (such as a 401k or an IRA) there aren’t any requirements for minimum distribution options. An HSA also stays with you for as long as you’re alive. It doesn’t go away if you leave your employer or even if you change your health plan. If you do choose to invest the HSA funds for the long haul, it’s important to select a provider that has low costs and great investment options.
The third and final tax-saving benefit of an HSA is that you can withdraw money from your HSA at any time after you turn 65 for any reason. The only caveat is that you’ll have to pay income taxes on funds withdrawn for non-medical expenses. If you have an HSA, your financial advisor can discuss strategies with you on how and when to use your HSA in retirement. The funds can still be used on just medical expenses, especially since healthcare costs are the second most expensive item in retirement. Another benefit to being able to withdraw funds from an HSA after 65 is that you can reimburse yourself for past medical expenses as long as the expense was incurred after you opened your HSA account.
For example, let’s say you opened your HSA account when you were 25. At the age of 60, you received knee replacement surgery and did not use your HSA funds to pay for the out-of-pocket costs. As long as you keep the medical bill and receipt, after you turn 65 you can reimburse yourself for that surgery by taking a distribution from your HSA. Doing so won’t affect your taxable income since this expense is a qualified medical expense and was not previously reimbursed or deducted.
In Conclusion
On top of the triple-tax savings of having an HSA, the funds in the account can also be used for healthcare costs in retirement such as long-term care insurance premiums, prescription medications, and many other common healthcare costs incurred in retirement. You can, of course, also use your HSA before your turn 65 but leave it mostly untouched so that you have a fund for large medical expenses, like surgery or childbirth. Your financial advisor can sit down with you to help you determine whether or not an HSA is the right choice for your financial goals and health needs. Just reach out and set up a meeting!
And be sure to check with your tax preparer on the specifics of any potential tax strategies or savings.
Thanks to the team at Caribou for contributing to this article.