Health Savings Accounts: A Major Trifecta!

Health Savings Accounts: A Major Trifecta!

It’s that time of year again: OPEN ENROLLMENT!

Probably one of the most overlooked employee benefits, with both tremendous tax advantages and the potential to serve as a retirement planning tool, is the Health Savings Account (HSA). Not only are all contributions tax-deductible, but withdrawals are tax-free provided they are used for qualified medical expenses. But wait, there’s more...! Earnings on these funds can also be tax-free, and there’s no “use it or lose it” provision—allowing you to build up an additional source of funds that can be for future health care expenses or as a source of income in your later years.

Tax-deductible savings. Tax-free funds to spend on health care. And the ability to roll over your funds from year to year. Those are three powerful reasons to get on board with an HSA. Want to learn more? Let’s start with the basics.

What is an HSA?

 
A lot of people think Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs) are the same. While they do have some things in common, they are in fact very different kinds of accounts. Both are funded with pre-tax contributions, and funds can be withdrawn tax-free to cover qualified medical expenses—but that’s where the similarities end.

Unlike FSAs, HSAs are only available in conjunction with a qualified High-Deductible Health Plan (HDHP). Contribution limits are usually adjusted annually, but unlike IRAs or other tax-deferred accounts, there are no income threshold limits. This feature makes HSAs especially attractive to high earners, who may have maxed out their retirement plan contributions and are looking for other ways to cut their tax bill.

Employees and/or employers can make tax-free contributions to the HSA. Yep! You read that right: your employer can match your HSA contributions, just as they would make matching contributions to your 401(k) plan. Finally, HSAs offer investment options; these differ from plan to plan, but most often they can be invested in bank-type instruments or mutual funds.

What are the benefits of having an HSA?

 
Besides providing a pool of tax-free money for medical expenses, HSA contributions can allow you to increase the amount you’re saving for retirement and seriously reduce your tax bill.

For 2017, the maximum contribution an individual could make to an HSA was $3400, and for families $6750. For people between the ages of 55 and 65, the catch-up provision comes into play and you can add an additional $1000 to your contributions, for a maximum of $4400 for singles, $7750 for families, or $8750 if both spouses are aged 55 to 65.

For 2018, the contribution limits have been increased by $50: for singles it’s $3450, for those age 55 or older $4450. For families, the 2018 limits are now $6900 at the baseline, $7900 if one spouse is 55 or older, and $8900 if both spouses are 55 or older.

So let’s walk through how this could work. Let’s say you’re single, aged 40, and have maxed out your 401(k) contributions at $18,000. You can enroll in an HDHP, sign up for an HSA, and sock away up to an additional $3,400, reducing your taxable income by a total of $21,400! If you are single and 55 or over and want to max out your contributions using the catch-up provision for both the 401(k) and HSA, you could drive down your taxable income by a total of $28,400.

How do I get an HSA?

 
First, enroll in a qualified HDHP. This is extremely important. Just because your health insurance plan has a high deductible doesn’t necessarily mean that it meets the requirements to be an HSA-qualified HDHP. Be sure to check with your insurance company or your employer to confirm the status of the plan before you sign up.

Next, decide how much you want to contribute. As described above, you can choose to fund your HSA up to the annual maximums—and because the contributions are tax-deductible, your income tax will be reduced as well. Also keep in mind that having a high deductible means that health insurance premiums will be reduced too. This make it a real win/win situation!

Here’s another example of how it all comes together. Let’s say you are single and 56 years old; you have a HDHP with a $2500 deductible, and are contributing the maximum of $4400 to your HSA. At some point in the year, you need some medical tests or procedures which amount to roughly $1500 in expenses. That $1500 can be withdrawn from your HSA—tax-free—to cover your medical expenses, while the balance of $2900 remains in the account and continues to grow—tax-free!

And here comes the really good news: unlike FSAs, HSAs have no “use it or lose” provision, so any balance remaining at the end of the year rolls over and can be used in the following years. Continuing to make additional tax-deductible contributions to this account can make it a powerful tool in your long-term planning arsenal. The proceeds can be used for most health-related expenses, such as medical visits, hospital stays, prescriptions, psychiatric care, dental treatments, and even insurance premiums for long-term care, to name just a few. For a deeper dive into qualified HSA expenses, check this IRS site.

To recap, here are the advantages of having an HSA:

  • Unlike FSAs, IRAs, and 401(k) accounts, HSA accounts do not require funds to be withdrawn by a certain date or age.
  • There are no “use it or lose it” provisions, allowing funds to remain the HSA account indefinitely.
  • Contributions are made pre-tax, effectively reducing your taxable income.
  • Withdrawals are tax-free as long as they’re used for qualified medical expenses, including paying the deductible on the health plan for you and/or your family members. Other withdrawals are subject to a 20% penalty as well as regular income taxes. However, the penalty is waived for participants 65 or over, or in the event of total and permanent disability or death.

So if you’re looking for ways to cut your tax bill, reduce your taxable income in the future, and have an extra “bucket” of tax-free money for to cover health care costs or use as income during retirement, an HSA could be your new best friend!

2018 vs. 2017 HSA Contribution Limits

 
Contribution and Out-of-Pocket Limits for Health Savings Accounts and High-Deductible Health Plans

 

 
2018

 
2017

 
Change

HSA contribution limit (employer+employee)

Self only: $3,450
Family: $6,900

Self only: $3,400
Family: $6,750

Self only: +$50
Family: +$150

HSA catch-up contributions (age 55 or older)*

$1,000

$1,000

No change**

HDHP minimum deductibles

Self only: $1,350
Family: $2,700

Self only: $1,300
Family: $2,600

Self only: +$50
Family: +$100

HDHP maximum out-of-pocket amounts (deductibles, co-payments and other amounts, but not premiums)

Self only: $6,650
Family: $13,300

Self only: $6,550
Family: $13,100

Self only: +$100
Family: +$200

 * Catch-up contributions can be made during the year by HSA-eligible participants who will turn 55 by year-end.
 ** Unlike other limits, the HSA catch-up contribution amount is not indexed; any increase would require statutory change.
Note: Contributions for a given year may be made until the individual’s federal tax return due date for that year, without extensions, in which case the HSA administrator must indicate that post-year-end contributions are attributed to the prior calendar year.

 

Sources: IRS, Bankrate.com, HSAcenter.com