What is an HSA?
Health Savings Accounts, or HSA’s, are essentially personal bank accounts that can be used for medical expenses. Contributions are made tax free as well as withdrawals when they are made for qualified health expenses. People tend to use these accounts alongside their retirement plans to reduce their taxable income.
How does an HSA Work?
HSAs are only available for those with a high deductible health insurance plan (HDHP). Typically, an HDHP is a health insurance plan with lower premiums but higher deductibles. For 2023, the IRS defines a high deductible health plan as any plan with a deductible of at least $1,500 for an individual or $3,000 for a family. All the money contributed to an HSA account is tax exempt if it is used on qualified medical expenses. The money in the account is free to earn interest or be invested in market-based securities as well. If the funds are withdrawn for non-medical purposes, they will be subject to income tax as well as a 20% tax penalty.
HSA accounts allow you to pay your health bills from untaxed income rather than out-of-pocket which has already been taxed. Health savings accounts are like bank accounts in the aspect that you will receive a debit card to pay for your medical expenses. At the end of the year the money in the account rolls over and never expires.
The annual contribution limits for 2023 are $3,850 for individuals and $7,750 for family coverage for families plus an additional $1,000 catch-up contribution for anyone age 55 or older by the end of the tax year.
Here is an example of how an HSA could work for you and your family:
- Husband and wife, both 50 years of age at the beginning of funding.
- Combined Federal and State tax rates of 40%.
- Funding the maximum of $7,750 per year (based on 2023 figures and NOT taking advantage of the additional $1,000 annual contribution beginning age 55). Total funding of $116,250 over 15 years (age 50 through age 65).
- Incurring $4,000 per year in medical expenses that will be paid from the HSA account.
- Investing the remaining $3,750 per year at 6% annual rate of return until age 65. For simplicity, example assumes all monies in the account would be spent at age 65 on medical expenses. In reality monies would stay in the account well after age 65 and provide more benefit than calculated in this example.
- Total outlay of $116,250 to HSA account over the 15 years.
- Cash paid for medical expenses using pre-tax money from age 50 to 65 will be $60,000.
- Pre-tax account balance at 65 to be used for future medical expenses $94,000.
- Total pre-tax dollars available to pay medical expenses are $154,000 with only $116,250 invested.
- Had they not used an HSA account, but paid after-tax dollars, they would have needed $256,000 to pay for the same $154,000 in medical expenses.
- The total savings in this example are about $140,000 over the 15 years which equates to about $10,000 per year or $800 per month.
Who is Eligible
In order to set up an HSA, you must meet five requirements:
- You must be covered by an HDHP.
- You are not eligible for Medicare.
- You do not have access to another health insurance plan that is not an HDHP.
- You are not claimed as a dependent on someone else’s tax return.
- Contributions cannot be made after the participant attains age 65 and is enrolled in Medicare.
Overall, there are many benefits to an HSA. One of the best parts of the health savings account is that the list of expenses that qualify for the spending is large. This list of qualified medical expenses includes items such as dental services, deductibles, vision care, as well as co-pays. Another great advantage of an HSA is that anyone can contribute if they meet the eligibility requirements. Contributions can come from people like relatives and employers. A couple of other pros are the convenience factor, the pretax contributions, and the annual rollover. The significant upside is that unused contributions rollover and will grow year over year. This rollover of tax-free earnings allows the account holder to pre-fund medical expenses and use tax free earnings to pay for future medical expenses in retirement.
Along with the advantages come some disadvantages. One of the main disadvantages of an HSA account is the requirement for a high deductible insurance plan. Another downside is the record keeping aspect, when paying for the medical expenses you must keep track of them in case you get audited by the IRS. Along with that, a second drawback of a health savings accounts are the fees. Some HSAs charge a minimal monthly account fee.
If you would like more information or help deciding if a health savings account is right for you then click the link below to get started with us today.