Key Points:

• Health Savings Accounts (HSAs) give individuals who have high-deductible health insurance plans a tax-efficient way to save for current and future medical expenses.

• HSAs are often considered one of the most tax efficient and powerful savings accounts available today.

• As part of a long-term savings strategy, it may be best to pay for current medical expenses out-of-pocket, allowing the funds in your HSA to grow until you need them for more expensive medical bills during retirement.

Health Savings Accounts (HSAs) were first established in 2003 under the Medical Prescription Drug Improvement and Modernization Act. Since 2011, the amount in HSAs has grown from about $6.76 million to $22.21 million in 2017. This is in direct response to the increasing cost of health insurance premiums and medical expenses in the United States.

Health Savings Accounts give individuals who have high-deductible health insurance plans (HDHP) a tax-efficient way to not only pay for current medical expenses, but to also save for future medical expenses. With healthcare costs at an all-time high, it has become increasingly important to manage and pay for medical expenses in the most resourceful way possible.

How You Can Contribute to an HSA

To participate in an HSA, you need to be covered under an HDHP. An HDHP is defined as any plan with a deductible of at least $1,350 for self-only coverage and $2,700 for family coverage. One benefit of choosing a HDHP is that your monthly premium is usually much lower than other plan options. The drawback is that if you experience a medical issue, the higher deductible means higher out-of-pocket costs before your co-insurance kicks in. A HDHP is typically most appropriate for younger, healthier individuals, with little to no history of medical issues. However, even for older individuals, the risk of paying higher out of pocket medical costs with an HDHP could be offset by the lower monthly premiums and the tax benefits of an HSA.

Why HSAs Are So Tax Efficient

Health Savings Accounts are often considered one of the most tax efficient and powerful savings accounts available today. (See Figure 1.) Contributions to an HSA are “pre-tax”, meaning they avoid federal and state income tax, acting as an adjustment against your taxable income. There are annual HSA contribution limits for individual self-coverage and family coverage.

Using HSAs to Save for Retirement

As mentioned above, an HSA holds money earmarked for medical expenses. Typically, it is better to save for medical expenses using an HSA rather than your checking account, because you’ll be paying with money that was never subject to ordinary income tax. (See Figure 2.)

However, while you may feel inclined to pay for all of your medical expenses with your HSA, there may be a better long-term answer. Because there is no requirement to use HSA funds in the current year, you can allow the money in your account to grow, tax deferred, for future medical expenses.

Retirees generally pay more for healthcare than younger, healthier individuals. Therefore, a good strategy for individuals with an HSA is to pay for current medical expenses out-of-pocket, while still contributing to the HSA. This allows the funds in the HSA to grow until you use them for more expensive bills in the future. And, at age 65, you are no longer subject to a 20% penalty on distributions for nonqualified medical expenses. This means that without substantial medical expenses in retirement, your HSA can be treated like a traditional IRA if you withdraw money (subject to ordinary income tax).

Health Savings Account Opportunities

If you’re a healthy individual who can tolerate some risk, a HDHP could save you money on your monthly premiums and grant you access to an HSA. While you may be tempted to pay for all your medical bills out of your new HSA, it could be best to allow those funds to grow for the payment of more expensive bills in the future. Everyone’s situation is different, and it is important to consider your individual circumstances when deciding if a HDHP and HSA is right for you.

Sources:

https://dpath.com/2019-hsa-contribution-limits/

https://www.healthcare.gov/glossary/high-deductible-health-plan/