It’s easy to ignore what we don’t understand – including something like an Health Savings Account. But plenty of professionals leave money on the table by not making the most of these tax-advantaged accounts.
It’s that time of year again. No, not the holiday season. I’m talking about something perhaps less exciting but still incredibly important: open enrollment. Your health for 2021 — and your future wealth — could hinge on the insurance plan you pick today. It’s important to review your options carefully, including the often-overlooked health savings account (HSA).
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If you’re ignoring HSAs because they feel like just another company benefit to manage, you’re not alone. Many companies offer HSAs, but 80% of organizations say their employees don’t read benefits materials. If you’re one of the many people who glance at benefits paperwork before tossing it aside — until your HR team harasses you to fill it out — you’re probably leaving money on the table by not understanding the advantages of an HSA.
HSAs can cover prescriptions, ambulance fees, and many other healthcare expenses. These accounts can be especially valuable during a pandemic because of the higher likelihood of medical costs. Plus, opening and funding an Health Savings Account can save you thousands of dollars in taxes. One of my clients, for instance, opened an HSA in 2019 and was able to save $2,000 in taxes by contributing the maximum amount to the account — he contributed early this year, too, and will likely save another $2,000.
In 2021, you can contribute $3,600 for individual coverage and $7,200 for family coverage (plus $1,000 more if you are 55 years or older). Some employers contribute to HSAs for their employees, but it’s important to remember that this amount counts toward your annual limit. If your company makes a $500 contribution to your HSA, for instance, $3,100 is the maximum you can contribute in 2021.
Tips To Benefit From Health Savings Account Tax Advantages
If you’re healthy and don’t have medical expenses during your plan year, Health Savings Account contributions can be carried over. The ability to invest and carry over funds makes HSAs “hackable,” and many people are able to grow their HSAs as tax-advantaged savings vehicles. If you want to hack your account while benefiting from the HSA tax advantages, follow these strategies:
1. Learn the ins and outs of your plan.
First things first: To be eligible for an Health Savings Account, you must be enrolled in a high-deductible health plan. Understand how a high-deductible health plan stacks up against other plans, your potential out-of-pocket costs, and what’s covered under an HSA.
For 2021, the IRS defines a high-deductible health plan as one with a deductible of at least $1,400 for individuals and $2,800 for families. That means you will pay at least this much out of pocket before your insurance kicks in. For people who make frequent visits to a doctor, a traditional healthcare plan may be more appropriate.
While hundreds of healthcare-related expenses are covered by HSAs, most medical expenses considered cosmetic or related to health insurance premiums aren’t eligible. For clarification, your HR or benefits team can provide a list of HSA-eligible expenses and answer any questions you might have.
2. Max out your HSA early.
HSA tax advantages are greater than the tax benefits from other investment accounts. Traditional 401(k) plans and IRAs provide tax benefits upfront, while Roth 401(k)s and Roth IRAs provide them at withdrawal. An Health Savings Accountoffers tax benefits upfront and at withdrawal! And while 401(k) and IRA contributions are still subject to payroll taxes, contributions made to your HSA directly through payroll deductions avoid both Social Security and Medicare tax. If your company has a 401(k) match, you should invest whatever you need to get that match first. Then, max out your HSA before you contribute to any other retirement accounts.
Healthcare costs are hard to predict, and an unexpected visit to the hospital could mean taking out a loan against your 401(k) or piling on credit card debt. An HSA gives you access to funds when medical expenses come up and a welcome tax break. Why not invest here first?
As an example, let’s consider a client of mine who recently landed himself in the emergency room. He was required to pay $5,600 out of pocket for the hospital visit. He already contributed to an HSA, so he thankfully didn’t have to tap into his savings or emergency fund. My client contributed the maximum in 2009 and 2010 ($5,950 and $6,150, respectively) and invested his HSA for growth over the past 10 years. At an average 7% growth rate, his HSA grew to almost $24,000 — more than enough to cover his hospital visit this year!
3. Add cash and let it grow.
Investing your contributions is one of the lesser-known advantages of an HSA. Only 6% of Americans who have HSAs invest their funds, and the rest are overlooking an enormous benefit of HSAs — compound growth. My clients typically have enough cash or a healthy emergency fund to cover medical expenses out of pocket, so I advise them to contribute the maximum to their HSAs each year and treat the accounts as long-term investment tools. Instead of using their HSAs to cover medical bills, they invest that money and let it compound to receive every HSA tax advantage.
Let’s look at another client of mine, a 25-year-old who plans to contribute at least $3,550 to her HSA each year. If at 45 she decides to change to a traditional healthcare plan — but allows the HSA to keep growing — her Health Savings Account would be worth more than $750,000 by the time she’s 65 (assuming an average 8% return)! If she doesn’t have medical expenses in retirement, she can make penalty-free withdrawals for any reason after she’s 65. All she’d have to do is pay income tax on the distribution.
Though few people understand what an HSA is and how it works, the benefits are unmatched when it comes to long-term savings for medical expenses or retirement. Explore your company’s healthcare plans and the options available to you, and then get started on the road to a comfortable retirement by setting up an HSA account — and making the most of it.
About the Author
Daniel Lee, CFA, CFP®, is a financial planner at Plancorp dedicated to helping busy people make intelligent financial decisions by providing clear, straightforward advice free from conflict of interest. He is currently the head of Plancorp’s San Francisco office. Plancorpis a full-service wealth management company serving families in 44 states. Daniel is an award-winning instructor at UC Berkeley Extension and is a member of the CFA Society of San Francisco and the National Association of Personal Financial Advisors (NAPFA).