Health savings accounts (HSAs) may be one of the best financial vehicles you can use for effective financial planning. Why? If used properly, HSAs offer tax-deductible contributions and tax-free withdrawals. That is correct, no taxes at all if used correctly. Better still, HSA dollars do not “expire” at year-end, unlike many health-related savings accounts, and may be invested to generate additional tax-free dollars.
To qualify for an HSA, you must be a participant in an HSA-compatible insurance plan. Typically, this means a group, or employer-sponsored, high-deductible health insurance plan. The plan must also meet the requirements for deductibles and out-of-pocket expenses. Limits and amounts change often, so it is important to research or ask your financial professional for clarification. Once a participant in a qualifying insurance plan, you can fund an HSA. Most employers, if offering a qualifying plan, will also offer enrollment in a corresponding HSA. Contributions are made before taxes, thus reducing your taxable income similar to 401(k) contributions. Yearly limits apply and change often, so again, contacting a financial professional or researching on your own is critical.
One area that requires immediate attention is for HSA owners who are reaching the age of 65. All individuals, who qualify, have the ability to begin Medicare benefits during the month of their 65th birthday. Enrolling in Medicare, even auto-enrolling in Part A, will disqualify any future HSA contributions, even if you are still working and not taking Social Security. Any Medicare benefit enrollment precludes HSA contributions. However, if you do have a balance in your HSA, you can keep it and continue to use those funds until they run out. Additionally, you can use HSA funds to reimburse yourself for qualifying Medicare premiums.
Using HSA funds to pay for qualifying medical expenses is easy, and payments remain tax-free. Using HSA funds for non-qualifying expenses will create a tax and penalty consequence if under age 65. For example, if you use HSA funds to buy a car, you will incur a 20% penalty and be required to report those funds as taxable income in the year received. Depending upon your tax bracket, using HSA funds for non-qualifying expenses before age 65 could result in taxes and penalties up to 59.6%. However, after age 65 the 20% penalty disappears for non-qualifying expenses, leaving only taxes due based on income.
Aside from regular medical expenses, HSA funds can be maximized in retirement in several ways. First, if you retire and accept Medicare benefits prior to taking Social Security benefits, you can use HSA funds to cover Medicare Part B and D premiums. Second, you can use HSA funds to pay for long-term care insurance premiums and take advantage of the tax-free treatment. Third, you can pay for group health insurance premiums with HSA funds. For example, if your employer allows you to remain on their health insurance plan or you purchase a personal health insurance policy before turning age 65, you can use HSA funds to cover the premiums.
We are all familiar with how a 401(k) works: You put money in every paycheck, invest those funds over time and, ideally, watch them grow to allow for a comfortable retirement. However, many do not use HSA funds as an investment vehicle, and this is a mistake. Unlike flexible spending accounts or health reimbursement accounts, HSA funds do not “expire” at the end of every year. Furthermore, leftover HSA funds may be invested yearly and can grow tax-deferred. It is not uncommon for prudent HSA participants to enter retirement with a significant amount in their HSA that provides an additional source to cover retirement expenses, particularly those associated with the ever-rising cost of medical care.
If you have a health savings account or are eligible to participate in one, understand and research your options to maximize your potential while avoiding penalties, additional taxes and disqualification via Medicare. Seeking professional help and advice will ensure you are adequately prepared to maximize your HSA.