A Health Savings Account or HSA is a medical savings account that is attached to a high deductible health insurance plan. It can be a savvy way to save money by reducing your overall medical spending. It can also have compelling retirement savings benefits.
Money can be deferred into an HSA account on a pre-tax basis just like a traditional 401(k) or IRA contribution. When money is withdrawn to cover qualified medical and dental expenses, withdrawals are tax-free.
How Can an HSA Save You Money?
An HSA saves you money in four compelling ways.
HSA contributions are tax free: Contributions to your HSA are made before your income is taxed. So, you are taxed as if you make less money. (For example, if you make $75,000 a year and you put $4,450 into an HSA, you are only taxed on $71,550.)
Money in an HSA grows tax free: Any interest or investment returns you earn on your HSA are tax free. You do not pay any taxes on growth in the account.
Withdrawals for eligible medical expenses are tax free: Any money you withdraw from the account to be used on eligible medical expenses is tax free.
High deductible health plans are usually less expensive: Most high deductible health plans have lower monthly premiums than other kinds of plans. Typically, the higher the deductible, the lower the premium. (However, these plans are not the best type of insurance for everyone.)
So, money in an HSA is truly tax free — you do not pay taxes on that money anywhere in the cycle. And, you could potentially save money on a lower cost health plan.
How do you qualify for an HSA? What is a high deductible health insurance plan?
You can open an HSA if you have a high-deductible health insurance plan.
A high deductible health insurance plan is one that has minimum deductibles as defined by the IRS. For 2018 those minimums are:
- $1,350 for a single person
- $2,700 for a family
A plan with deductibles lower than this does not qualify as high deductible per the IRS and an HSA can’t be used with it.
A deductible is the amount of money you need to pay toward your health costs before your insurance starts picking up the bill. After you have met your deductible, then you are usually still required to pay a copay for services until your out of pocket maximum is met.
So, if you have a $2000 deductible with a $5,000 out of pocket maximum, then you will fund your medical costs until you have spent $2,000. Thereafter, you will probably have a copay until you have spent $5,000.
The general rule of thumb is that high deductible plans are good for people who are generally healthy. However, they can be problematic if you have a sudden and serious medical issue.
What are the contribution limits to an HSA?
The IRS also sets the amount that can be contributed to an HSA on a pre-tax basis. For 2018 the annual limits are:
- $3,450 for an individual
- $6,900 for families
- Those who are 55 or over can contribute an extra $1,000
What are the out-of-pocket maximums for 2018?
There are also limits on the amount of out-of-pocket expenses, including coinsurance, copayments and deductibles. For 2018 these are:
- $6,650 for an individual
- $13,300 for a family
What is the difference between an HSA and a Flexible Spending Account (FSA)?
You may have also heard of a Flexible Spending Account (FSA).
Both the HSA and the FSA are health savings accounts where your contributions are made on a pre-tax basis. They also share the ability to use the funds in the account to cover qualified medical and dental expenses on a tax-free basis.
The key difference between the two accounts is that the FSA is “use it or lose it.” This means that money contributed to the FSA must be spent in that year or it will be lost. Money contributed to an HSA can be carried over from year-to-year, hence the reason it can be used as another retirement savings vehicle.
Consider an HSA as a retirement savings account: It’s probably the most tax advantaged way to save
HSAs have an interesting side benefit as being a potential source of tax free retirement savings.
Because money in an HSA can be carried over from one year to the next, you could carry these very tax free funds into retirement.
An HSA is clearly the most tax advantaged investment option available. And, as yet another retirement benefit, there are no minimum required distributions at 70 1/2 as there are with other kinds of retirement accounts.
The key to this strategy is using other funds to cover out-of-pocket medical expenses while you are working, letting the HSA funds grow until retirement.
Many company HSA plans have investment options. Additionally, many banks and investment custodians offer HSA accounts with investment options similar to IRAs.
Once you get to retirement, funds can be withdrawn from the HSA to cover a wide range of qualified medical and dental expenses. In addition, the cost of long-term care and Medicare premiums are considered to be qualified expenses. Any funds not used for qualified medical expenses can be withdrawn after age 65 without a penalty. Just like an IRA, these withdrawals will be subject to taxes. There is a wide range of expenses that are considered as qualified.
With the ever-increasing cost of medical care in retirement, an HSA can be a valuable addition to your retirement savings efforts.
How will medical expenses and your plan to cover them impact your overall retirement plan?
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