Health savings accounts (HSAs) are one of the best types of investment accounts available and most people don’t know anything about them. It can be better than a 401(k), an IRA and even a Roth IRA. Those accounts are good, but this one is even better.
Maybe it’s not well known because of its name. Maybe people think of it as some type of insurance policy. No matter the reason, if you qualify to have one, you would be wise to learn a little more about this little-known investment account. It can make a huge difference financially for you and your family, especially in your retirement years. (For more, see: High-Income Benefits from a Health Savings Account.)
What Is a Health Savings Account?
A health savings account is better known by its abbreviation, HSA. While your 401(k) and IRA accounts can provide a reduction in your current taxes and do not incur taxes as they grow over the years, you will pay income tax on the distributions you take to fund your retirement years. The Roth IRA doesn’t give you a current reduction in taxes, but the distributions you take at retirement are tax free. The health savings account gives you triple tax benefits. The contributions you make are tax deductible, the account grows tax free over the years, and if managed properly, the funds are tax free when withdrawn.
A health savings account is designed to help you set aside money for health care expenses. But unfortunately, not everyone is eligible for an HSA account. To qualify, you must be enrolled in a high-deductible health plan (HDHP). For 2017, an HDHP is defined as a health insurance plan with an annual deductible of at least $1,300 for an individual or $2,600 for a family. The plan must also limit out-of-pocket expenses like co-pays and deductibles to $6,550 for an individual or $13,100 for a family.
How Much You Can Contribute
For 2017, the maximum contribution allowed is $3,400 for an individual or $6,750 for family coverage. If you are over 55, you can make “catch up” contributions of $1,000. You can contribute monthly, or you can make a lump sum contribution for the previous year up until your tax return comes due - April 15 for most people. If you have health insurance through your employer, and the plan qualifies as an HDHP, you can make your contributions via payroll deduction. Many employers will even provide a matching contribution as an employee benefit. It’s important to note that you cannot make contributions once you hit age 65 and are enrolled in Medicare. Your contributions into the account can be invested in a wide range of investment vehicles, including mutual funds, exchange-traded funds (ETFs), stocks and bonds. (For more, see: Rules for Having a Health Savings Account.)
The most important thing to know about health savings accounts is that the distributions are tax free only if you use the funds for qualified medical expenses. You can make those distributions for yourself, your spouse or your dependents. If you take a distribution and do not use the funds for medical expenses, the amount of the distribution is considered taxable income and there is a 20% penalty tax. The penalty goes away once you reach age 65.
You can make distributions anytime you have qualified medical expenses to pay. However, one strategy that many folks use is to pay the day-to-day medical expenses out of pocket and allow their HSA to grow. For most people, medical expenses are a bigger part of the budget in their later years. This strategy allows you to accumulate tax-free dollars for those expenses.
Maybe one reason that HSAs are underappreciated is because of some misconceptions that surround them. A lot of folks confuse them with flexible spending accounts (FSAs). These are the accounts that many people contribute to through payroll deduction. You can use the funds to pay for qualified medical expenses through the year, but these funds are “use it or lose it.” In other words, you must use the funds by the end of the year, or you lose them. Funds in your HSA account do not expire.
Another common misconception surrounding HSA accounts is that you can have one only through your employer. This is simply not true. If you have a qualifying HDHP, you are eligible to contribute as an individual.
The Bottom Line
There are some rules that you have to know and follow to take full advantage of this special tax-favored account. But if you are eligible, this little-known account can have a big impact on your financial future. (For more from this author, see: Medicare Enrollment Part 1: When to Enroll.)