In June, Michael shared a concept called The Hierarchy of Savings that we discuss with many of our clients. This provides a great roadmap of where you should consider putting your money to work in order of importance. Another option that may be available to you is a Health Savings Accounts.
This strategy falls as an alternate #7 in Michael’s list, assuming you have cash reserves for 3-6 months, you’re maximizing your employer sponsored plan contributions, you’re saving for your children’s college 529 plans, and contributing the maximum to your Roth IRA. Another important assumption is that you are covered under a qualified high-deductible health plan (HDHP). For 2021, qualified HDHP must have a minimum deductible of $1,400 for individuals or $2,800 for families and a maximum out-of-pocket deductible of $7,000 for individuals and $14,000 for families. If your HDHP meets these requirements, you may be eligible to open an HSA through your employer or in the private marketplace. Other requirements include1;
- You are not covered by any other medical plan (such as your spouse's plan)
- You are not enrolled in Medicare
- You are not enrolled in TRICARE or TRICARE for Life
- You are not claimed as a dependent on someone else's tax return
- You are not covered by medical benefits from the Veterans Administration
- You do not have any disqualifying alternative medical savings accounts, like a Flexible Spending Account or Health Reimbursement Account
Why save in an HSA?
Saving in an HSA is powerful because it is Tax Advantaged. To demonstrate the tax advantages, let’s assume you meet the requirements listed above and your employer offers an HSA that you can contribute the 2021 maximum of $3,600 for individuals or $7,200 for families to via pre-tax payroll deductions (tax deductible for private HSAs). Those age 55 or older can contribute an additional $1,000 per year. These contributions stay in your HSA year after year, unlike a Flexible Savings Account (FSA) which must be spent by the end of each year. Your HSA can also be transferred to a new employer plan or private plan as your life changes.
To maximize the tax benefits, we assume you cover the majority of current medical expenses out-of-pocket and invest your full contributions within your HSA. Growth in your HSA investments are tax-free if they stay inside the HSA and distributions for qualified medical expenses2 are tax-free. Distributions prior to age 65 for non-medical expenses are subject to a 20% penalty and ordinary income taxes. After age 65, non-medical expenses from your HSA are not charged a penalty, but are still taxed at ordinary income rates.
Unlike IRAs, HSA are not subject to Required Minimum Distributions (RMDs).
- You qualify to open an HSA
- You contribute pre-tax dollars (or tax-deductible) to your HSA
- Investments in your HSA grow tax-free
- Distributions for qualified medical expenses are tax-free for life
- Distributions for non-medical expenses are subject to ordinary income tax and a 20% penalty prior to age 65
- After age 65, non-medical expenses are not subject to a penalty, but are subject to ordinary income taxes
Several Tax Advantages! In other words, you may never pay tax on these dollars if used correctly. The HSA is a powerful tool to help cover medical expenses in retirement to keep your other assets working for you, or as an additional tax-deferred income source. If you're planning for retirement, we’re here to help. When deciding if using a HSA is appropriate for you, we suggest consulting with your advisors including a CPA or tax advisor.