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At HCM, we try to build tax efficient strategies into every aspect of your wealth and retirement planning. One of HCM’s “Golden Rules” is to never pass up an opportunity for tax-free compounding. Health Savings Accounts (HSAs) are just the type of tool we like because they are a tax savvy way to save for future medical bills, including age based long-term care premiums and nursing home expenses later in life. Even though they have been available since 2004, many people still don’t know what they are or fail to take full advantage of their tax benefits.
Why Use an HSA?
In addition to being a great way to save for health expenses, it is triple-tax advantaged:
- Contributions are either pre-tax or tax deductible.
- Growth on the account’s investment earnings are tax free.
- Withdrawals for eligible health related expenses are tax free.
Because the money invested in your HSA is pre-tax, it lowers your taxable income. For example, if you made $100,000 and invested $7,000 in your family’s HSA, you would only be taxed on the remaining $93,000. If you are in the 22% tax bracket you would save $1,540.
An HSA is also preferable to other accounts, such as a Flexible Spending Account because the money in your HSA is yours to keep, without limits. Other such accounts require you to “use it or lose it” at the end of each year.
When it comes time to pay for healthcare, you can either use the money in your HSA or pay cash and reimburse yourself later taking advantage of the tax-free growth. This is where it gets interesting. Let’s say you have an eligible healthcare bill of $7,000. You pay that bill today with cash and keep the receipt. At the same time, you put $7,000 to work in your HSA. Five years go by. At a 7% return, the $7,000 in your HSA would be $9,818. At that point, you could either reimburse yourself the $7,000 with funds from the HSA or let the money remain invested tax free and reimburse yourself later. Either way, you now have $2,818 that you earned by tax-wise investing that you never would have had without the HSA. And, if you ultimately use it for eligible medical expenses, you will never pay tax on it. There’s no deadline for reimbursement, so you can do this as often as you would like for as long as you’d like, earning tax-free income on money that you essentially have already spent. And, if you don’t want to worry about record keeping for later reimbursement, you can simply pay future medical expenses with your HSA funds. The real planning advantage is gained by taking advantage of tax-free compounding made possible by utilizing the tax-free investment HSA environment.
Rules and Requirements
HSAs must be paired with High Deductible Health Plans (HDHPs). Currently, a HDHP is defined as having a deductible of $1,350 for an individual and $2,700 for a family. In 2020, the minimum deductible for an HDHP will be $1,400 for an individual and $2,800 for a family. If you’re interested in this, when shopping for healthcare make sure the plan you’re considering is described as “HSA-eligible.”
There is a cap on how much you can contribute. For 2019 it’s $3,500 if you have single coverage or $7,000 if you have family coverage. However, if you’re 55 or older, you can contribute an extra $1,000. In 2020 the limits will be increasing, with $3,550 for an individual and $7,100 for a family. The extra $1,000 amount for those over 55 will remain the same.
Also, the IRS is pretty strict on making sure you only use HSA funds on eligible expenses. If you don’t use the funds correctly, you’ll owe income tax on the ineligible funds withdrawn as well as a 20% tax penalty.
It is HSA Day on October 15th
What should you do on HSA day? If you would like to know more, there will be a live webinar that speaks to the benefits of health savings accounts. They are useful not only as a method for paying for eligible health care expenses, but also as a vehicle for investment and retirement income.
At 3pm Eastern time on October 15th, you can tune in to the website hsaday.com to listen to Jean Chatzky, an educational ambassador for HSA Day.
Unsure if an HSA is right for you? You can use this calculator to compare a High Deductible Health Plan with an HSA versus a traditional plan. If you have questions, give your HCM advisor a call. If you are not an HCM client, we would be happy to discuss your individual situation with you.
About the Author: Jake Butcher
As a Wealth Advisor and Partner, Jake became a member of HCM Wealth in 2010. He earned a Bachelor’s Degree in Finance and International Business Minor from the University of Cincinnati. Jake is a CERTIFIED FINANCIAL PLANNER™ professional and a member of the HCM Technology Committee.
He enjoys spending time with his wife, Katy, daughter, Milly, and son, Graham. Some of his hobbies include, playing basketball, golf, tennis, trying new restaurants and cheering on the UC Bearcats.