Health Savings Account—The Multipurpose Savings Plan

A Health Savings Account (HSA) is among the most flexible tax-advantaged savings tools available today.  Among the key attributes of HSA plans are that they provide their users the ability to save for future healthcare expenses and also provide another method to help investors save for their retirements in a tax-deferred way.

What is a Health Savings Account?
An HSA is a special savings or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. It is designed for individuals and families with a high-deductible healthcare plan (HDHP) and can be used to accumulate tax-sheltered cash for these healthcare expenses. An HSA can be a very cost-effective plan for younger participants that are in good health.

Many individuals and families have chosen an HDHP to reduce the rising cost of insurance. If you have an HDHP, you should consider the advantages provided by an HSA account.

There are multiple uses for an HSA account, and it comes with several tax advantages:

  • Contributions are tax deductible or pre-tax (if made via payroll deduction)
  • HSA funds remain in your account until you use them (i.e. accumulate year to year if they are not spent)
  • Investment income inside the plan grows tax-free
  • Withdrawals are tax-free when used to pay qualified healthcare expenses.

Additionally, there are even ways to use the savings account for non-health related expenses. Here is a deeper look into qualifying and utilizing an HSA.

Qualifying for an HSA Account?

  • You must be presently enrolled in a HDHP
  • You cannot be covered under another health plan
  • You cannot be enrolled in Medicare
  • You – or your spouse, if enrolled in a family plan – cannot have other health care coverage via a Health Flexible Spending Account, unless it is a limited purpose account.

How Much Can You Contribute?
For 2020, the maximum contributions are $3,550 for individual plans and $7,100 for family plans – an increase of $50 for individual coverage and $100 for family coverage from 2019 amounts. Individuals and employers can contribute; however, employer contributions are counted in the total HSA contribution limit. Additionally, for individuals who are 55 or older by year end and who have not enrolled in Medicare, an additional “catch up” contribution of $1,000 may be made.

Employee and employer HSA contributions are not subject to federal income tax and are not subject to state income tax in most states, including Massachusetts. Contributions for a given year may be made up to the due date of your individual income tax return – usually April 15th – without extensions.

How Can I Use My HSA?

Your HSA dollars can be used to help pay the health insurance deductible and any ongoing qualified medical expenses as defined in IRS Publication 969, including those not covered by health insurance, like dental and vision care. An HSA also provides a longer-term savings tool for future health care expenses.  Any funds you withdraw for nonqualified medical expenses will be taxed at your income tax rate, plus a 10% tax penalty.

The two most common ways to use an HSA are:

1)  To cover ongoing healthcare expenses.

2)  To save for future health care expenses.

The former uses the HSA as a short-term strategy to cover ongoing healthcare costs, while the latter allows you to use it as long-term savings plan, effectively leveraging your investment. To use it as a long-term savings plan, you would pay your health care expenses “out of pocket” while letting the HSA investment grow.

HSA distributions are tax-free to the extent the distributions are used to pay “qualified medical expenses” for you, your spouse, and your dependents. Refer to IRS Publication 969 for the definition of qualified medical expenses.

What if I Don’t Expect Significant Future Health Care Expenses?
If you use your HSA funds for non-qualified expenses, there are some tax consequences.

  • Taxable as ordinary income plus a 20% penalty if used for non-qualified expenses before age 65.
  • Taxable as ordinary income if used for anything else at age 65 or thereafter.

If you are fortunate to have future good health, you have several options for utilizing your HSA.

  • HSA funds can cover prior health costs. You may have paid for your ongoing health care costs prior to retirement, allowing your HSA to grow. Your HSA can now be used for expenses other than current health related costs.
  • As long as you have saved your health care receipts, and your withdrawal is equal to or less than the amount of these health care expenses, you qualify for a tax-free withdrawal. The prior health care expenses don’t need to have been incurred in the year of withdrawal; you can go back years, so save your receipts. However, certain conditions apply, such as the old medical expenses need to have been incurred after the HSA was established.
  • After age 65, you can use your HSA account to cover just about any expenses. For example, you could use these funds to pay for a cruise without a penalty. The withdrawal would be taxed similar to a withdrawal from an IRA or 401(k) plan—effectively making the HSA a flexible retirement savings vehicle. This flexible plan can allow you to benefit from having made pre-tax contributions and tax-free compounding for potentially many years.
  • The HSA account can cover long-term care premiums or long-term care costs. Depending on your age, you can use an HSA to cover long-term care premiums. The IRS sets limits on the amount you can use and updates these limits annually. If you created an HSA account in your 20s, you may be able to use it to pay long-term care premiums in your 70s or 80s.  Alternatively, you can make withdrawals to cover long-term care expenses as they are incurred, which better leverages the tax-free growth potential.

Last But Certainly Not Least:

Your HSA has additional financial planning benefits too.

  • Portability – you can take your HSA account with you if you change employers.
  • Transferability – upon death, your HSA can be transferred to your spouse tax free, just like an IRA. However, transferring to a non-spouse would be 100% taxable as ordinary income.

If you are eligible for an HSA and want to save on taxes and for the future, you owe it to yourself to consider an HSA.  An HSA can be a key component of your retirement plans. The rules are complex, and we recommend that you contact your tax advisor or an HSA trustee for more specific information.