Many of us have heard that Health Savings Accounts (HSA) are excellent vehicles to pay for healthcare costs. In fact, according to research compiled by Devenir, as of June 30, 2022, there were about 28 million HSA accounts. Additionally, total funds in HSAs grew to $98 billion at year-end 2021 from $45 billion in 2017. Clearly, the word’s gotten out about the benefits of HSAs. However, questions remain about the nuts and bolts of using these accounts and how individuals and families can maximize their benefits. This article reviews the most prominent features of HSAs while exploring some of their lesser-known benefits.
The first requirement to be eligible for an HSA is an employee must also have high-deductible health insurance. An individual, employer, or both can put pretax dollars in the account. If an individual puts pretax dollars in the account, this directly lowers their taxable income. For 2023, the maximum HSA contribution is $7,750 for a family and $3,850 for an individual, plus an additional $1,000 for participants aged 55 and older. The most significant feature of an HSA is there is no tax on the money going into the account, the funds grow tax-free, and there is no tax on the withdrawals if used for qualified medical expenses. Of the various retirement accounts, HSAs are the only one with this triple tax benefit.
Another powerful feature of HSAs is funds held within the account can compound for years, with most account sponsors offering several investment choices to allow the money to grow. Also, HSAs can act as a raining day fund, as account owners skip reimbursements for current healthcare costs but can be reimbursed for years (even decades) later if they keep receipts. They can also take tax-free withdrawals for retirement health costs such as Medicare Part B and Part D premiums and for Medicare Advantage premiums. They cannot be claimed for Medigap supplemental coverage but can be used to pay for COBRA premiums. HSAs, unlike other health savings vehicles, have a wider variety of health expenses that are eligible for reimbursements, such as eyeglasses, some dental procedures, and even qualified long-term care insurance. Additionally, after age 65, HSA funds can supplement retirement income, as owners can withdraw money for nonmedical expenses. However, if funds are withdrawn for nonmedical expenses, individuals must pay taxes on the funds, just like a regular IRA distribution. HSAs are also portable, as individuals, not employers, own the account. Once you leave an employer, you can roll your HSA to a provider that meets your goals and preferences.
One of the lesser-known benefits of an HSA is that children of a parent with an HSA can qualify. For example, Sally, age 24, is employed but still has health insurance through her parents’ high-deductible plan with an HSA. If she is not claimed as a dependent, Sally can contribute to her own HSA, even if her parents have maxed out theirs for the year.
HSAs are not without a few downsides. If you or a member of your family are heavy users of healthcare or suffer from chronic illness, then the deductible limits for a high-deductible healthcare plan can be cost prohibitive. Also, some high-deductible healthcare plans have hefty co-pays, which can add up. Additionally, unlike traditional and Roth IRAs, HSAs can’t be inherited, except by a spouse. Otherwise, the assets become taxable at death. An estate executor can use HSA funds to pay for medical expenses within one year of the owner’s death.
With the 2023 employer open enrollment season right around the corner, it might be time to take a closer look at a high-deductible healthcare plan with an HSA. Despite the few downsides of an HSA plan, the overall benefits of these accounts are significant. The tax law is rarely generous, but in the case of HSAs, it’s one of the areas of the law that can provide significant and lifelong benefits to the taxpayer and their families.