Value of a Health Savings Account

December 15, 2015

I call Health Savings Accounts (HSA) the tax planning Holy Grail! Beginning in 2003, HSA’s allow for families enrolled in a high-deductible health plan to invest up to $6,650 ($3,350 for individual plan) in a tax advantaged vehicle that is to be used for medical expenses. Check with your healthcare provider if your health plan is considered “high deductible”. Any contributions to an HSA are considered adjustments to your Adjusted Gross Income (AGI) (lowering AGI is more valuable than itemized deductions!). AGI is used to determine different floors that limit deductions. In short, we want AGI as low as possible to maximize our available deductions and, of course, limit taxes.

Many HSA providers have different investment options that you can create a moderate growth allocation. Every plan is different, but at a minimum you will likely be paid some sort of (likely small) interest on your balance, tax free when used to pay for qualified expenses*.

Any distributions that have unrealized taxable gains as part of the account are considered tax-free if used for a qualified medical expense (that’s the catch, I guess). To my knowledge, this is the only tax advantaged vehicle that allows tax deductible contributions AND tax free withdrawals! Hence, it’s the tax planning Holy Grail!

In summary, you get a tax deduction similar to what a Traditional IRA can give but not have to pay taxes later when you take a distribution, similar to a Roth IRA**? We all know that, at a minimum, health expenses are going to be a big part of our budget during retirement.

In addition to this feature, an HSA also offers some flexibility for retirement individuals. If you have an HSA balance when you reach age 65, you can withdrawal funds penalty free and just pay the taxes like a Traditional IRA. An HSA is super valuable! Also, note that after age 65, HSA dollars can be used to pay for Medicare Part B and Long term care insurance premiums, and it is tax free! Fantastic! Contact your health administrator to find out if your insurance plan qualifies you to enroll in an HSA.

*Note that withdrawals from an HSA for non-qualified medical expenses are subject to income taxes, and if made prior to age 65, a 20% penalty tax may apply.

**Traditional IRA offers tax deduction at certain income limits. Contributions for 2015 are limited at $5,500 ($6,500 for those over 50). Withdrawals made prior to age 59 1/2 may be subject to a 10% penalty tax. Withdrawals from a Roth IRA are tax-free if made after age 59 1/2 and held in the account for 5 years. Otherwise, income taxes and a penalty tax may apply on earnings withdrawn. 

This article is intended to provide general information and should not be considered tax advice. You should consult a tax advisor for specific information on how tax laws apply to your situation. Investing involves risk including loss of principle.