Last year marked the twentieth birthday of one of my favorite ways to save, the health savings account (HSA). The HSA came into existence through the Medicare Modernization Act signed into law by President George W. Bush on December 8, 2003.
What is a health savings account?
The HSA is a tax-advantage account that allows an individual to save for and pay for medical expenses. It was not the first medical savings account, but today’s HSA is more widely available and enjoys additional flexibility compared to its predecessors. According to the 2022 Year-End Devenir HSA Research Report, there are 35.5 million HSAs worth more than $104 billion for account holders across the United States.
Why is it one of my favorite accounts? When used properly, the HSA offers triple tax savings. Account holders can make pre-tax contributions, investments can grow tax-free, and when used on qualifying medical expenses, distributions are also tax-free. Now that calls for a celebration!
Before we hand out noisemakers and balloons, let’s talk about the requirements that must be met.
What are the HSA requirements?
To open and save with an HSA, a person must meet these requirements: be enrolled in a high-deductible health insurance plan (HDHP), not be enrolled in Medicare, have no other healthcare coverage, and not be claimed as a dependent on someone else’s tax return.
High-deductible health plans have higher deductibles (out-of-pocket amount you are required to pay toward a covered claim) and lower premiums (amount you pay your insurance provider each month). With the funds in your HSA, you can pay for out-of-pocket medical expenses.
How does an HSA work?
While HSAs can be opened by an individual (discuss with a financial advisor or look for “health savings account” online), they are generally employer-sponsored and paired with your HDHP option. When employer-sponsored, both the employer and the individual can contribute pre-tax dollars to the account, up to the IRS contribution limit. Many employers offer HSA contributions as a benefit.
For 2024, the limit is $4,150 for individuals and $8,300 for family coverage. For those who are fifty-five or older, there is an additional $1,000 catch-up contribution. The limit is aggregate. If the employer contributes $1,000, the individual can only contribute an additional $3,150 (or $7,300 for family coverage).
Once the money is contributed to your HSA, it is yours. You do not lose it if you don’t use it. It is also portable, meaning that if you change jobs, you keep your HSA account. You also have the option to invest the cash in your HSA.
When you take withdrawals for qualified medical expenses, they are tax-free. You can use your HSA funds to purchase prescriptions and over-the-counter medications, braces or Invisalign, acne medication, hearing aids, substance use disorder treatments, and so much more. You can review the full list on the website of your specific HSA or on the IRS website. Qualified medical expenses incurred by your spouse and dependents also count, even if those family members aren’t on your insurance plan.
Many HSAs issue a debit card which makes it convenient to pay for medical expenses while providing an easy paper trail for tax purposes. You can also reimburse yourself using the funds within an HSA if you paid for medical expenses with another form of payment. In all cases, you need to keep records of your receipts.
Why would someone with an HSA consider using another form of payment for qualified medical expenses? One of the most advantageous benefits of the HSA is that you don’t have to reimburse yourself in the same year you had the expense. With this flexibility, an individual could invest their money today with plans to reimburse themselves in the future – what I like to refer to as the HSA’s superpower.
HSA superpowers explained.
The ability to invest the funds within your HSA, coupled with the flexibility to reimburse yourself in future years, is how a person can maximize the flexibility of the HSA.
Invest the funds in your HSA. Many plans will require you keep some money in cash. Once you satisfy the cash level, you can direct your HSA to invest all future contributions. Generally, you will see some mutual fund options (like your 401k or 403b). Some plans even offer brokerage account access which allows access to a broad range of investment options, even individual stocks. Remember, you are taking risk with investments. If you aren’t comfortable with the chance that the money can decline or be completely lost, you shouldn’t invest.
Pay for medical expenses from cash flow, and pay yourself back tax-free in the future. If you can comfortably cover your medical expenses from cash flow/reserves and not use the funds in your HSA, do so and save your receipts. By keeping receipts of your medical expenses, you can pay yourself back in the future, ideally from gains, and use those funds for anything.
For example: Your HSA account has grown to $50,000 over the last seven years and your medical receipts now total $10,000. The Disney cruise your family will love will cost about $10,000. You can pull out that money tax-free from your HSA since you have the receipts totaling the same amount – paying yourself back from gains.
Options for retirees exist. According to the annual Fidelity retiree healthcare cost estimate, a typical retired couple (sixty-five or older) could expect medical expenses throughout their retirement to cost as much as $315,000. You could be in a strong financial position to cover those costs if you have dedicated your HSA account for savings in previous years.
And finally, the HSA has one more flexible trick up its sleeve. Once you reach the age of sixty-five, you can choose to treat the HSA like a qualified retirement account. You can take withdrawals from your HSA for anything but will pay taxes on it just like you will from your traditional IRA, 401k, 403b, or any other pre-tax qualified retirement account.
It is all about the fit.
While I could spend all day talking about the many benefits of the health savings account, it is only beneficial if it works for your situation. When your employer’s open enrollment arrives, or if you’re self-employed or your employer does not offer an HSA, take some time to look at all your options and determine what fits your situation best. And remember, the HSA turns twenty-one this year – that calls for a champagne toast!
