Health Savings Accounts, or more commonly known as HSAs, are a tax haven hidden in plain sight. HSAs are paired with what the IRS determines to be “High Deductible Health Plans” or HDHPs. For 2021, these plans were required to have a minimum deductible of $1400 for an individual and $2800 for a family. If your plan meets these requirements and is categorized as an HDHP plan, you are eligible to contribute to a HSA. Note that there are more complicated requirements for families with one HDHP and one non-HDHP health plan.
How a HSA works
In short, you and possibly your employer/plan will contribute money to the HSA account which can later be used for qualifying health expenses. This account can be accompanied by a debit card, or can be used on a reimbursement basis. Either way, you’ll have a dedicated pot of money to use for health-related expenses. Be prepared to save receipts to substantiate your reimbursements. Personally, I use Google Drive for this.
Contribution limits
Okay, let’s get down to the nuts and bolts. If you are a single tax filer, your 2021 contribution limit will be $3,600, with a limit of $7,200 for us married-joint filers. If you are 55 or older you have an extra “catch up” provision of $1000 per year. The $7,200 is the total family limit even if both spouses are eligible for separate HSA plans. Additionally, this $7,200 also includes any “pass through” contributions from the plan or contributions from your employer.
Where to open an HSA
You’re probably wondering where you should open a HSA or if you have to go with the HSA designated by your employer. The answer is, “it depends” and “no”. For us, my employer uses HSA Bank as their vendor. I don’t like the investment options with HSA Bank, so I only keep the $1800 plan contribution in that account, which we end up using for co-pays, prescriptions, etc. I contribute $5400 to a separate account at Fidelity through payroll deduction.
If you have a good employer plan, you may choose to use the full $7,200 ($3,600 if single) of space in that account. The short story is – you aren’t limited to a certain number of HSAs, but rather, limited by contribution limit. For us, there is some added bonus because my employer permits payroll deductions which exempts my contributions from FICA (social security and medicare) taxes.
The Tax Benefits
I know… you still haven’t been convinced to switch to a HDHP with a HSA. Well, get ready, because the HSA has triple tax savings:
- The money you contribute is not taxed, and if you contribute through payroll contribution, it is also exempt from FICA.
- The money grows completely tax free (yes, all those gains and NO TAXES!)
- The money is then withdrawn tax free for eligible expenses either now or in retirement.
That’s right, this is the hat trick of tax breaks (that is hockey speak for 3 goals in a game by a single player). You’re probably wondering what “eligible expenses” are. For present day, you can take a look on the IRS website or your provider page for a list. I’m not going to get into them as the list is very extensive and would be a waste of valuable learning space in this article. Starting at 65, you can use your HSA funds to pay Medicare premiums, authorized health expenses, or use the funds like an IRA in which case you will be taxed at your normal rate but will not pay a penalty. So regardless of claims otherwise, the HSA is, in fact, a retirement account, and a very good one at that.
The Flip Side
So at this point you are probably trying to figure out what the catch is. There are a couple. First, you will have a higher deductible. So if you have a health expense early in the first year you switch to a HSA you might have some significant out of pocket costs. As far as risk, that first year really assumes most of it. We have been in our HSA plan for about two years now, and have spent $3k in authorized medical expenses and have an HSA balance of $13,500 today. Considering we don’t plan on touching the Fidelity account, we believe this balance should be at a safety net-level very soon. With that said, we will continue to use the HSA Bank account to pay for medical expenses such as doctor bills and prescriptions.
Second, you need to understand that some states don’t recognize the pre-tax nature of HSAs, so do some research on your individual circumstances before committing. There is also some risk that your state or the federal government changes HSA regulations in the future, which could impact the taxability of your investment. But again, this is the same risk that we assume with the IRA, 401(k), 403(b), etc. Don’t freak out, but just know that legislative changes are sometimes unexpected and this is certainly no different.
Where Does it Fit?
Here at The Wealthy Idiots, we talk a lot about the whole picture. Being diverse, having multiple buckets, knowing where your money goes, etc. So by now, you’re probably wondering how the HSA fits into that. Well, what we know is that medical costs are increasing at an alarming rate. So alarming that medical expenses in retirement are probably the biggest variable. For us, we plan on continuing our $5400 contribution to Fidelity. At a conservative 5% return, we expect to have in excess of $250k at retirement. That is a QUARTER MILLION DOLLARS for medical expenses, medicare premiums, long-term care expenses, and if needed, retirement withdrawals. This is a very flexible account that can add yet another bucket to your diverse retirement portfolio.
