Health Savings Accounts, or HSA’s, are qualified savings accounts used to pay for qualified medical expenses. You need to enrolled into a High Deductible Health Plan (HDHP) to be eligible to contribute, and savings in these accounts may just be the best investment you can make! Let’s explore.
What are Health Savings Accounts?
HSA’s are a savings feature associated with high deductible health plans. High deductible health plans have lower premiums than other HMO or PPO health policies, but also come with higher deductibles and higher out of pocket maximums. High deductible health plans are great for those with lower medical costs as many times the savings from lower premiums outweigh the larger deductibles.
Because of the higher deductibles and out of pocket costs, health savings accounts are eligible with these plans to help save for current and future medical expenses. For tax year 2021, the maximum contribution to a HSA is $3,650 for individual coverage or $7,300 for family coverage (family coverage is defined as you and at least one other family member). Those age 55 and over can contribute an additional $1000 per year.
Many employers will also offer an employer contribution as a benefit for enrolling into a high deductible plan. HDHP plans save employer premiums as well and they in turn may wish to ‘reward’ employees with an HSA contribution. All contributions between both the employee and employer cannot exceed the contribution limits listed above.
Triple Tax Benefits
So what makes HSA’s so special? It’s the tax benefits. HSA contributions are tax-deferred like an IRA, meaning you reduce your taxable income by the amount contributed. But they also grow tax-free and distributions are tax-free if used for qualified medical expenses, making them the best account to save into from a tax perspective. Let’s look at an example.
A married associate veterinarian has $150,000 in income, placing them into the 22% marginal tax bracket. By contributing the family maximum of $7,300 into an HSA, this would save $1606 in federal taxes every year ($7,300 * 22%), much like an IRA contribution or pre-tax 401k contribution would work.
However, HSA’s also grow tax-free, meaning no tax will be due on any interest, dividends, capital gains that are received in any given year. And the big kicker, any distributions made to cover qualified medical expenses are considered tax-free as well. The deductible contributions, tax-free growth, and tax-free distributions make HSA’s the only account that offers triple tax benefits.
Investing
Another feature of HSA’s that many people are unaware of is the ability to invest your savings. Most plans do require a minimum amount to be held in cash, typically around $1,000, but anything above and beyond this amount can be invested.
This is where the power of tax-free growth and future tax-free distributions come to life. Unlike a Flexible Savings Account (FSA), HSA’s do NOT have to be distributed before year-end. These account balances can be allowed to accumulate and grow for years. By investing your HSA funds you can harness compounding interest with the prospect of growing your HSA funds to pay for future medical costs, such as health premiums if you decide to retire before Medicare age.
How you choose to invest your HSA funds should be taken in context of your overall financial plan and also according to the anticipated time horizon of when the funds may be needed.
How to best use HSA’s
As mentioned above, there is no need to withdraw from your HSA in any given year. Sure, if you need the funds to pay for medical expenses in any given year, please do so. But ideally, HSA’s would be used like this:
Contribute the most you can, up to the annual maximum limit. When you have exceeded the minimum amount to be left in cash, invest the remaining amount in a target date fund or low-cost index funds. If medical expenses are incurred, pay for the costs out of pocket instead of withdrawing from your HSA if your cash flow allows. By paying for medical costs out of pocket, you are allowing your HSA to continue to grow. The growth achieved by long-term investing can then be used to cover health costs in the future tax-free, whether that be due to future medical issues or possibly covering expenses when considering early retirement.
For example, let assume the family maximum of $7,300 is contributed into an HSA for 5 years. The HSA funds are invested and earn an annual return of 6%. After 5 years, the total amount saved into the HSA is $43,619. Even without contributing any more dollars into the HSA, 20 years later with no distributions the amount saved into the HSA is $104,537! This can certainly provide some flexibility and coverage for future medical costs.
| Beginning Value | Annual Addition | Ending Value 6% Growth | |
| Year 1 | $7,300 | $7,738.00 | |
| Year 2 | $7,738.00 | $7,300 | $15,940.28 |
| Year 3 | $15,940.28 | $7,300 | $24634.70 |
| Year 4 | $24634.70 | $7,300 | $33,850.78 |
| Year 5 | $33,850.78 | $7,300 | $43619.83 |
| Year 20 | $98,620.24 | $104,537.45 |
Reimbursement
Another feature of HSA’s is the ability to reimburse yourself for medical expenses paid out of pocket in previous years. Say you had medical costs of $5,000 10 years ago. If for whatever reason you need to access cash, you can use your HSA to reimburse yourself for these expenses, essentially paying yourself back.
Of course, this requires you to keep track of your expenses and also save your receipts but you should most likely be practicing these anyway.
Conclusion
Health Savings Accounts are sometimes an afterthought when it comes to savings, but given the flexibility and triple tax savings, HSA’s should be a part of any financial plan when eligible.
For additional information about how an HSA can benefit you and your family or how to best utilize the investments and features, speak with a fiduciary financial planner who will act in your best interest to assist in making the best decision for you.
Andrew Langdon is a CERTIFIED FINANCIAL PLANNER™ and the founder of VetWorth, a fiduciary fee-only financial planning firm dedicated to serving the unique needs of veterinarians and their families.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Andrew Langdon, and all rights are reserved. Read the full Disclaimer.
