May 27, 2016
Health Savings Accounts
Should you have a Heath Savings Account?
Many employers currently offer Health Savings Accounts (HSA’s) to their employees, leaving many employees and investors alike to ask, “Is an HSA right for me?” Traditional thinking suggests the answer to this question depends on one’s medical plan and annual medical expenses. However, due to the account’s tax treatment, there is more to be considered.
HSA’s are the only tax-preferred savings vehicles that offer both tax-deductible contributions and tax-free withdrawals, provided distributions are used to pay for medical expenses. This unique tax treatment has created an unconventional retirement savings vehicle and begs the question, “should an HSA be part of my retirement savings strategy?”
In today’s healthcare landscape, investors would be prudent to save for future medical expenses in addition to general living expenses. Many people though, choose to save for both in the same vehicle, a qualified retirement account, like an IRA or a 401(K). Splitting savings into a combination of a retirement account and HSA can create a powerful resource for funding future health-care costs in retirement. The tax treatment of HSA accounts is so advantageous that investors may want to contribute to an HSA before they contribute to an IRA, sometimes even before they contribute to a 401(K).
An individual is penalized for a HSA distribution that is not used for medical expenses and therefore should not be used as the only retirement savings vehicle. However, provided other accounts have been amply funded in the past or are also being contributed now, max-funding an HSA, even if one must cut back on other savings, is often the right choice for investors. The resulting savings and eventual distributions from the HSA have the potential to be the most tax efficient dollars in the entire portfolio.
How does it work?
HSA accounts are savings accounts to be used for medical expenses and are given preferential tax treatment when used accordingly. Contributions to these accounts can be made with pre-tax dollars and employer contributions are not included in an employee’s taxable income. Withdrawals from HSA accounts are tax free when used for medical expenses and are subject to a 20% penalty and regular income taxes if not used for qualifying medical expenses. The penalty is waived for individuals over age 65. Meaning, should an investor over the age 65 use their HSA funds for non-medical costs, the money is treated the same a traditional IRA.
Qualified medical expenses are typically any medical expense that would normally qualify for the medical expense deduction. Included are also insurance premiums for health care under COBRA or while receiving unemployment. Medicare premiums can be paid with HSA dollars and so can long-term care insurance premiums, up to a limit.
Unlike a flexible spending account, balances roll over each year and can continue to accumulate indefinitely. Providers often allow balances to be invested and the gains on these assets are not taxed until they withdrawn – either taxed as income (non-medical expenses) or not at all (qualified medical expenses), another excellent perk of the HSA.
Who can contribute?
Employees that participate in a “high-deductible medical plan” are eligible to contribute $3,350 as an individual and $6,750 as a family (2016) on a pre-tax basis, as long as they are not covered by other health insurance. A “high-deductible medical plan” is any medical plan that carries a deductible of $1,300 – $6,550 for an individual or $2,600 – $13,100 for a family (2016). Additionally, persons over the age of 55 can contribute an additional $1,000 as a “catch-up” contribution annually.
How do you use it?
The most common use of an HSA is for an employee or their family to use the account to pay for medical expenses during the current year. This is still better than paying medical expenses out of pocket, where the expense deduction is limited to 10% of adjusted gross income. As long as the account is not exhausted, the remaining funds roll over each year and accumulate.
Alternatively, depending on current income and tax obligations an investor might elect to not use the HSA to pay for medical expenses now. They could continue to save money in the HSA for use in retirement, treating the account like a traditional IRA, to be used exclusively for medical expenses in retirement. The reason to forgo using the account now is that many people should expect medical expenses to be dramatically higher in retirement. According to Fidelity’s annual “Health Care Cost Estimate” a 65 year old couple will spend a shocking $245,000 during retirement on medical expenses.
The downside to taking such an approach is that current year medical expenses must be paid out of pocket and HSA eligibility is dependent on having a medical plan with a high deductible. This could place a tremendous burden on cash flow. Obviously this strategy should never be considered for a family with high medical costs. For people that don’t typically incur high medical expenses, the HSA can still be used to cover the unexpected medical costs, even on a reimbursement basis. Meaning, you could pull money from your HSA in November to cover medical costs from January if needed.
Before using an HSA to fund retirement costs, you should consult with a financial planner and a tax professional regarding your specific situation. 401(K) contribution matching, your income, tax obligations, and current savings can all impact the effectiveness of this strategy. Please don’t hesitate to contact us if you have any questions.
This commentary on this website reflects the personal opinions, viewpoints and analyses of the Gainplan LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Gainplan LLC or performance returns of any Gainplan LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Gainplan LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.