You may have been hearing that HSAs are the triple threat, allowing you to reduce your taxes today and earn tax-free income for your future. Right now, there is no other investment that allows you to do this, so see if this is right for you. I actually think it’s a seven-time win, and here’s how:
Money you put into an HSA saves you taxes today
You fund your HSA through deferrals from your paycheck that come out before taxes. This reduces your taxes for this year. Say you earn $75,000 per year and defer $3,450 to your HSA, the max for a single filer. Your reportable income is now reduced by that $3,450 to $71,550. Doesn’t sound like much? If you’re in the 22% tax bracket, that’s nearly $800 you paid to yourself instead of Uncle Sam – Win #1.
Money that comes out of an HSA can be tax-free
Once the money is in the HSA you can use it to pay for qualified medical expenses. These can be as basic as your co-pays and deductibles at the doctor or hospital or quite complex (see IRS Publication 502 for a complete list). Money comes out of the HSA tax-free, as long as it’s a qualified expense. Win #2.
Money in your HSA can help you save for your future
So far, this sounds a lot like your Flexible Spending Account (FSA), but, here is where they diverge. If you don’t use all of the money that you’ve set aside in your HSA, it simply rolls over to the next year. No more panic to use up your Flexible Spending Account at the end of the year, your Health Savings Account is different. This money is yours to spend when you want. Win #3.
Because your HSA money can roll over year after year, there is no fear in maxing out your contributions to it. If you have free cash flow, you can fully fund your HSA and then set it aside while you pay current medical expenses with current income. This will allow your HSA to grow – tax-free – as long as you use it for medical expenses. This is an excellent opportunity to have a tax-free form of “income” to pay medical bills in retirement or simply at some time in the future, when you may need it. Win #4.
Instead of simply sitting in a bank account waiting for you to use the funds, many HSA’s allow you to invest a portion of the dollars in there in underlying funds. Now your investment has the opportunity to grow with the markets and that growth is still tax-free if used for qualified medical expenses. Win #5.
Your HSA may come equipped with “free money”
And, in what I see as the coup de grâce, we have recently seen many local employers encouraging employees to take advantage of HSAs by offering an “employer match” into the account. Some of these are significant and most seem to be based on the amount you, as the employee, defer. For example, one company offered up to a maximum of $900 for single employees and $1,800 to married employees, pro-rated based on the employee contribution (as a percent of the maximum contribution limit). This additional deposit from the employer is free money. Remember, this money is yours, it can roll over within the HSA every year and an HSA goes with you, not the employer, even if you need to change jobs. This company match is not only free money in the sense that it is a company match, but, it is also tax-free income – today, and if you use it for qualified expenses in the future. Kind of like a company match in your 401(k), but, those 401(k) dollars will be taxed when you take them out in retirement. The HSA match may never be taxed (if used for a qualified medical expense). Win #6 & 7!
So, let’s be clear. HSAs and more specifically, high deductible plans are not right for everyone. You should be aware of their merits and drawbacks as well as your other options to save for retirement and reduce your taxes. Have the conversation with your financial advisor and family to determine if this is a good choice for you the next time you get to open enrollment.
The Details on HSAs
If you are in a high-deductible health plan and under the age of 65 you qualify for an HSA. This account allows you to set money aside, before taxes, to pay off those co-pays, deductibles and other medical expenses. For individuals in 2018, this means a plan with a deductible of at least $1,350 and maximum out-of-pocket expenses of $6,650. For families, it’s a deductible of at least $2,700 and maximum out-of-pocket of $13,300. There is also a $1,000 catch-up if you are 55 or older. If you use the funds for non-qualified expenses before age 65 you will not only have to claim the money withdrawn as income on your taxes but you will incur an additional 20% penalty on those funds. Finally, if you use the funds after age 65 for non-medical expenses, the 20% penalty is waived.
If it’s time to get your portfolio on-track for financial success, schedule a call with me to start the discussion.