Financially successful people have many things in common: they are good at making money, they find Prairie Home Companion tolerable, and they look through Williams Sonoma catalogs with the intent of actually buying something. They also — at one point or another — found a way to minimize their individual tax liability.
Most of the discussion surrounding tax-advantaged savings or retirement accounts center around 401(k)s, IRAs (Roth, Simple, SEP, etc.), and other major investment vehicles for a good reason. But those retirement savings plans have limits; you may not qualify for them, or you might have maxed out each tax year because your savings game is on point. If these retirement and savings vehicles are unavailable to you — or even if they are — a Health Savings Account may be your next best option.
What Is an HSA?
Here’s the IRS’ description of a Health Savings Account:
A health savings account (HSA) is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur.
Ugh, that description is such an IRS thing to say. BORING.
Here is its intended purpose: an HSA is designed to help folks with a High Deductible Health Plan (a $2,500 annual deductible or more) create a savings buffer to pay for big medical expenses. You put pre-tax money into the savings account, and it grows. With interest and everything.
How Does an HSA Help Save Money?
People in the retirement savings world will use terms like “triple tax-advantaged” to describe the HSA and refer to them as the “Ultimate Retirement Account.” If used correctly, they are right. HSAs combine the benefits of Traditional IRAs (deduction from gross income and tax-free account growth) with the advantages of a Roth IRA (post-tax contributions, tax-free growth, no required minimum distribution). It combines these features without any of the associated drawbacks of the two. And let’s face it, eventually you are going to need to pay for healthcare.
In plain English, up to $3,350 of your annual income (or $6,500 for a family) can go into an HSA account without getting taxed first or being subject to FICA. That money can grow tax-free. As long as you have qualifying and off-setting documented health care expenses sometime after you establish the account (doesn’t matter when), you can withdraw that offsetting amount for any purpose. And you can withdraw it without paying taxes on the withdrawn amount or the growth.
Could an HSA Cost You Money?
To establish an HSA, you need to have a high-deductible health plan (HDHP), which might as well be called a “pay out of pocket for stupid high medical bills” plan. These are plans for which you still pay a significant monthly premium all for the honor of paying your or your family’s medical bills. You pay those bills until you hit a pre-determined cap: anywhere between $1,300 to $12,900 for a qualifying HDHP. While HDHPs generally have much smaller monthly premiums than standard health coverage, they will cost a lot if you have an exceptionally bad year.
Let’s use my seemingly normal family as an example. In recent history, I have had to take one of my kids to the doctor for the following issues:
- A double ear infection.
- A wood tick irrevocably embedded behind an earlobe.
- A double ear infection.
- A strong suspicion that the youngest one swallowed a bobby pin.
- Some Congolese death flu or something.
- Another double ear infection.
We would not be living the Williams-Sonoma lifestyle if we had a High Deductible Health Plan when all these plagues fell upon our house. If you are a single, reasonably healthy person, though, this isn’t nearly as big of a concern for you. But for those of us with occasionally sickly and accident-prone wards under our care, an HDHP may not be an option.
The other major obstacle to taking full advantage of an HSA is that you have to have cash on hand. Remember above when I mentioned that your offsetting medical expenses didn’t need to come from the same year in which you make withdrawals? That is awesome from a return-on-investment standpoint because your HSA money stays in an account generating interest tax-free until you feel like withdrawing it. However, to take advantage of this, you have to pay for your medical expenses out of pocket. Some people can swing that, but most Americans can’t.
For those that can make an HSA work for them, it is an incredibly useful tax savings tool. There are not many tax-advantaged savings vehicles out there that can match the benefits of an HSA. But you must decide if you can handle the drawbacks before committing.
Featured image: “Pink piggy bank with stethoscope on light background” from Shutterstock.