What motivates high-income households to consider Health Savings Accounts? They have learned about the potential benefits that an HSA can provide, including a tax-free reserve of funds for medical expenses, a way to reduce taxes, and even a potential source of retirement income after turning 65. It may be worth exploring this option for yourself.
However, to open an HSA, you must first enroll in a high-deductible health plan (HDHP), a health insurance choice that may not be suitable for everyone. You can make tax-free contributions to your HSA account, and some employers may even offer a matching contribution.
HSAs offer three potential opportunities for tax savings. Your contributions to the account are tax-deductible, the earnings grow tax-free, and withdrawals are also tax-free as long as they are used for qualified medical expenses like deductibles, co-payments, and hospitalization costs. (Note that HSA funds cannot be used for health insurance premiums.)
HSA Tax Benefits. A large draw for many are the tax benefits inherent to HSAs:
- Contributions through an employer are always pretax
- You can invest the funds after your account balance reaches a certain level
- Distributions for qualified health expenses aren't taxable
Did you know that at age 65, your HSA can provide you with retirement income? According to current federal tax laws, HSA account holders who are 65 years or older can withdraw funds penalty-free for any purpose. You can use the funds to pay for Medicare premiums (excluding premiums for Medigap policies) or extended-care insurance premiums. Unlike other retirement accounts, HSA account holders are not subject to Required Minimum Distributions (RMDs). However, it's important to note that if you take a distribution that is not used for qualified medical expenses, you may face taxes and penalties depending on your age.
Despite the potential benefits of HSAs, some people may find them less attractive. One reason is the requirement to enroll in a high-deductible health plan, which means you must pay most of the costs of medical expenses out-of-pocket until the high insurance deductible is reached.
Another hurdle is simply saving the money. If you are responsible for paying your own health insurance premiums, finding extra money to fund an HSA may be challenging, particularly if you face other significant financial pressures. Additionally, if you have a chronic illness or medical condition, you may end up using all of your annual HSA contribution and reducing your account balance to zero each year. This works against the goal of accumulating a tax-advantaged healthcare fund over time.
One advantage of Health Savings Accounts (HSAs) over Flexible Spending Accounts (FSAs) is that HSA contributions can remain in the account and be used for future medical expenses without a deadline. Unlike FSAs, there is no "use it or lose it" penalty for HSAs.
It's important to note that if you use HSA funds for non-qualified expenses before age 65, you may be required to pay ordinary income tax as well as a 20% penalty. After age 65, you may have to pay ordinary income taxes on HSA funds used for non-qualified expenses. While HSA contributions are exempt from federal income tax, they may not be exempt from state taxes in some states.
If you're interested in using an HSA, the Internal Revenue Service (IRS) and your HSA provider can provide helpful information. The IRS recently reminded taxpayers that at-home Covid tests, face masks, and sanitizing wipes can be purchased or reimbursed through an HSA. The IRS also offers an interactive tool to help determine which expenses are HSA-eligible.
To get started with an HSA, speak to an insurance professional to see if you're eligible to enroll in a qualified high-deductible health plan (HDHP). If your employer already offers such a plan, you may not need to take this step. After enrolling in an HDHP, the next step is to find an HSA provider.