“The economy is more than a little unpredictable right now. It makes sense to discover as many ways to save money and avoid paying unnecessary tax as possible.”
by Debra May
As inflation continues to eat into Americans’ savings and retirement accounts and a recession is all but guaranteed, many working people are experiencing financial anxiety.
Although recent studies indicate that working people between the ages of 25-55 are embracing frugality, saving more money, and cautiously acquiring assets, this demographic isn’t necessarily assuming a rosy future. Many are looking for more tax-advantaged ways to grow and protect their money from growing threats, including increased taxes, inflation, high medical costs, and longevity risk. In such a volatile economic environment, it makes sense that people want more flexibility, control, and safety for every dollar.
Not originally intended as retirement savings vehicles, Health Savings Accounts are growing in popularity with younger workers and those with ten years or less until retirement. The triple tax-favored HSA is uniquely positioned to help hedge against out-of-control medical expenses and provide a way for workers to reduce their taxable income. If you have a high deductible health plan (HDHP) with relatively annual medical expenses, an HSA might make sense. Like an individual retirement account, HSAs allow you to make tax-advantaged contributions annually, subject to IRS limits.
HSAs provide three distinct tax advantages of which you should be aware. First, contributions to HSAs are federally tax-deductible. Several states also offer tax breaks for HSA contributions. You should check with your tax advisor to see if your state is one of them. Additionally, your earnings in an HSA grow tax-free.
When you withdraw money to pay your qualified medical bills, your withdrawals are tax-free. Examples of eligible expenses include:
- Insurance co-pays.
- Prescription and certain prescribed OTC medications
- Durable medical equipment and devices.
- Medical treatment that your insurance plan doesn’t cover.
You can also use your HSA to help pay a spouse or dependent’s medical expenses. However, you should be aware that if you decide to withdraw money for anything not considered a qualified medical expense, you’ll pay ordinary taxes on those disbursements. And, if you are under 65, you will also pay the penalty. Those older than 65 can take funds out penalty-free but are subject to ordinary income tax. Despite these potential pitfalls, the advantages of an HSA can be significant for those who carefully follow IRS rules.
HSAs and 401ks: A knockout combination?
Your HSA belongs to you and you alone. You own the funds and everything in your account, regardless of whether you change employers or your health insurance changes. You can turbocharge your retirement savings when you combine an HSA with a typically less-expensive high deductible health plan.
This portability gives HSA holders multiple advantages. Whether your employment status changes or you decide to retire, HSA money is yours to use for qualified medical expenses. That includes anything your previous employer might have contributed to your account. Unlike flexible savings accounts (FSAs) HSAs are not a “use it or lose it” benefit.
These vehicles have infinite rollover capabilities. You can roll over any money in the account at the end of the year or when you retire or change employers into another plan without penalties.
It’s critical to note that if your employment status changes, you may encounter a few HSA pitfalls. For example, if your company contributed funds to your HSA, those contributions will end once you leave your job. Also, if you move to a company where you no longer have HDHPs available, you won’t be able to contribute to your HSA. But, if you switch to a different employer that also offers an HSA program, you can roll over money from your existing HSA into the new one. After rolling over the funds, you can simplify things by closing your old account. Having multiple HSAs isn’t prohibited, but no matter how many you own, your total HSA contributions cannot exceed IRS limits.
In June of 2022, the IRS announced inflation-based changes for high-deductible health plans starting in 2023. Under IRS code §223(c)(2)(A). HDHPs are now defined as health plans with annual deductibles of a minimum of $1,500 for individuals and $3,000 for family coverage. HDHP health insurance plans may include both PPO plans and HMOs. HSA-eligible high-deductible plans also have specific benefit limitations. Other than qualified preventative care, which is no-cost even if you haven’t met your deductible yet, other medical services aren’t covered until you’ve met your annual deductible.
Another HDHP feature is that your plan has to be your only health insurance coverage. If you are on a spouse or partner’s health insurance plan or claimed as a dependent on someone’s tax return, you are not eligible for an HSA. You also can’t have an HSA if you have Medicare or other health insurance. You must do your due diligence to confirm that your health insurance arrangement is truly HSA-compatible. However, leveraging the multiple benefits of HSAs is worth every minute you spend researching or consulting your financial advisor.
The bottom line: While they are often a less understood and utilized benefit, health savings plans are gaining popularity, especially among younger workers faced with increased financial challenges. HSAs are versatile and offer numerous upsides, including tax advantages when strategically used.
HSAs may be powerful components in retirement planning for employees facing financial insecurity. HSAs can be leveraged to hedge against inflation, rising healthcare costs, and medical emergencies. Investment opportunities afforded by HSAs may help safeguard against other threats to retirement savings, such as longevity risk, sequence of returns risk, inflation, and increasing taxes. Depending on your financial life stage and unique goals, HSAs can be somewhat complicated to administer and maintain. However, with the assistance of your company’s HR department and guidance from a qualified financial planner or retirement income specialist, you can sort out the intricacies of HSAs and access the multiple benefits.
Health savings accounts have a few downsides, though, and you must look at those to determine if an HSA makes sense in your situation. For instance, HSA plans are not automatically invested. You must choose to invest funds automatically, and you could encounter additional fees with this option.
If you aren’t careful, you could accidentally access HSA funds for non-qualified expenses, subjecting you to income tax and penalties. Also, if you no longer meet HSA requirements, you can’t contribute more to your account. Still, despite these potential limitations, having an HSA might make sense for many people. Consult your financial advisor to learn more about this powerful, tax-advantaged option.
