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Every year, the health insurance premiums for my family creep up. So to help keep the costs under control, we often switch to a plan with a slightly higher deductible.
This year, that increase bumped us into the high-deductible category—$2,700 for a family, or $1,350 for an individual. That meant we could save some money in a health savings account (HSA).
I had heard of HSAs, but I thought you had to access them through an employer, like a 401(k). It wasn’t something my husband’s employer offered, and I’m self-employed. But it turns out I was wrong. Anyone who qualifies can open an HSA on their own.
The big benefit of HSAs—tax savings
HSAs can help you save on taxes in three different ways:
- You can contribute to them tax-free. “When you use an HSA through an employer, your money is put into the account on a pre-tax basis,” says Logan Allec, a CPA and owner of personal finance site Money Done Right. If you fund one on your own, you can deduct your contributions when you file your taxes.
- Your investments grow tax-free. You can invest the money in stocks or bonds or save it in an interest-bearing account, and the earnings or interest you gain from that money is not taxable, explains David Burkart, Medicare and health benefits specialist with Principium Tactical Wealth Management.
- And as long as you use the money to pay for certain medical expenses—deductibles, copayments, coinsurance, and some others, but not premiums—the withdrawals are tax-free.
This year, you can contribute up to $3,500 as an individual or $7,000 as a family. And you don’t have to spend the money—you can let it roll over and grow year to year.
“The idea behind a health savings account is to make these contributions, have them grow over the years, and then cash them out in retirement,” says Adam Beaty, a certified financial planner at Bullogic Wealth Management.
“If you have a funded HSA, you can save your medical receipts over the years and submit them in retirement to get all the money back. This allows your contributions and earnings to get exponential growth over the years,” he says.
HSAs aren’t good choices for everyone
For some people, the downsides of an HSA outweigh the savings potential.
The high deductibles and co-pays of a qualifying health insurance plan could wipe out the benefits of an HSA. Chane Steiner, financial advisor and CEO of Crediful, says, “Starting an HSA is generally a good idea if you are already enrolled in an high-deductible health plan, but that does not mean it is always smart to start the high-deductible health plan for the sake of an HSA.”
You need to keep good records. With HSAs, you need to be diligent with your documentation so you can prove that you used your withdrawals for qualified expenses.
You need to be sure you’ll only need the money for medical expenses. If you use the money for non-qualifying expenses before age 65, you’ll face taxes and penalties, Burkart says.
Ken Rupert, founder and CEO of Financial Black Belt Academy, points out that after age 65, you can use the money in your HSA for any expense without paying a penalty. But you pay taxes on your withdrawals for non-medical expenses.
You need to be on solid financial footing. “While HSAs provide amazing tax benefits, for some folks, tax benefits are not the first thing on their list of financial priorities,” Allec says.
“If you have, say, $3,000 in extra cash that you’re looking to deploy in the most financially intelligent way possible, and you’re choosing between paying off high-interest credit card debt versus contributing to an HSA, I would say that you should probably pay off your credit card debt,” he says.
Medicare complicates things
As you approach the age where you’re eligible for Medicare, you’ll need to evaluate your HSA. Once you enroll in Medicare Part A or B you can’t contribute to your HSA, since you no longer have a high-deductible health plan.
“You must also wait to collect Social Security benefits,” says Burkart. That’s because when most people start collecting Social Security, they are enrolled into Part A automatically. “So if you want to keep getting the HSA contribution benefits you should delay Social Security and decline Part A of Medicare,” Burkart says.
You also need to plan ahead—you should stop contributing to an HSA seven months or more before you enroll into Medicare. “When you enroll in Part A you are entitled to receive up to six months retroactive coverage, meaning you could incur a tax penalty,” Burkart says.
You can still withdraw money to pay for medical expenses after you enroll in Medicare. Travis Price, a licensed insurance agent with I Fix Medicare, says after you retire you can use the money in your account to pay for:
- All qualifying medical costs
- Medicare advantage premiums
- Medicare prescription drug premiums
- Part B premiums
Adam M. Hyers, an independent insurance broker with Hyers and Associates, says, “You can even use your funds to pay for long-term care insurance.”
Before starting an HSA, it’s a good idea to seek professional advice. “Make sure to consult your tax professional for additional counseling on HSA contributions or withdrawals,” Burkart says.
