Client Question: Health Savings Accounts

September 8, 2022

When discussing the upcoming annual enrollment season (the time of year when employees need to elect various health care and employee benefit elections), a client recently asked for a refresher on Health Savings Accounts (commonly known as HSAs). These are very powerful tools – both for health care costs as well as for long-term investing strategies. Read on to learn more!

What exactly is an HSA?

An HSA is a tax-advantaged account available to those who have a qualifying high-deductible health plan (HDHP). These accounts allow consumers to utilize pre-tax funds to pay for medical expenses, which tend to be higher under plans with higher deductibles (hence the tie-in between HSAs and high deductible plans). In 2022, a HDHP is deemed one with deductibles of at least $1,400 for an individual, or $2,800 for a family.

How are these funded?

HSAs are funded either by individuals (usually via payroll contribution) and/or via employer contributions. Regardless of source (your money or employer money), the annual limit cannot be exceeded. For 2022 – (these will change each year) are $3,650 for an individual, $7,300 for a family. Plus, there’s an extra $1,000 annual catch-up contribution for those 55 and over.

Wait, don’t these funds expire every year?

Nope. Funds in an HSA will roll over year after year. This is in contrast to another health expense account that is rather popular – a Flexible Spending Account – which does cover a set calendar year only

Do any income limits apply?

There are no income limitations (as there are for other accounts, such as Roth and traditional IRAs). The only requirement is having an eligible health insurance plan

What does “tax advantaged” mean as it relates to HSAs?

As noted above, HSAs are tax-advantaged accounts. In simple terms, that means there are tax advantages to funding these accounts. In fact, HSAs offer some of the most significant tax advantages available and are affectionately deemed “triple tax free”:

Tax free element #1 – Contributions made to HSAs are deducted from income and not subject to federal income tax (depending on where you live, may also be deductible for state income tax purposes)

Tax free element #2 – Contributions and any earnings (see note below on investing opportunities) grow free of federal tax

Tax free element #3 – Withdrawals from HSAs for qualified medical expenses are tax free, whenever you take them. These expenses can include deductibles, copayments, prescriptions, medical equipment, and other costs not covered (vision, hearing, long-term care)

Why would I use an HSA for health-care costs?

For many individuals – and especially those with high deductible plans – health care costs can be considerable. Utilization of a Health Savings Account allows consumers to use pre-tax funds for these costs. If you are able to invest the funds (see next section), the benefits may become more meaningful

Why/how do you use an HSA for investment purposes?

As outlined above, funds contributed to an HSA can grow triple tax free – deductible on front end and no taxation on earnings or growth over time or at withdrawal (if used for medical expenses). Given these advantages and the potential for these funds to be used over multiple years (or decades), many HSA administrators allow the funds in the accounts to be invested.

The ability/desire to invest HSA funds varies by individual. For an individual with sufficient cash flow, they may choose to pay current health care costs with other money, fully fund an HSA, and invest the HSA for the long-term future (as they would an IRA or 401k). Again, this approach is most effective if HSA funds are left alone to grow/appreciate – given the tax advantages. In the far off future, those funds (that in theory have appreciated over time with the market) can be withdrawn tax-free to cover medical expenses

For many HSA users, understandably, there isn’t the cash flow to fully fund an HSA and then pay medical costs with other funds. As a result, in those cases, they usually fund the HSA and leave it in cash for use in the near term (usually in the same year). This still allows for a savings – as cash in these accounts is pre-tax money

Lastly, some HSA users are somewhere in the middle of these approaches – investing a portion of the funds and keeping some in cash for known/expected near-term costs.

There is no one size fits all approach. As always, the answer is “it depends” but given the importance and magnitude of health care costs, be sure to speak to your advisors when funding and/or investing in these accounts

Anything else to consider?

It’s easy to get swept up in the buzz of HSAs. Many individuals rave about them and their tax benefits. Without a doubt, they can be very effective on many levels. However, keep in mind what triggers their existence in the first place – a specific type of health insurance plan.

Be sure to do the required due diligence (involve specialists and advisors as needed) to determine the health care plan that is best for you and your family. Having access to an HSA is only one feature to consider. Be sure you give all criteria of the plan options you are presented with their due during this important process

Note: All commentary above is as of the date of this post and is for education and informational purposes only. Windermere and its principals do not intend for this to serve as investment advice and are not responsible for any actions taken based on this article. Consult your financial advisor before taking any actions as it relates to your own investment portfolio

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