Discover the benefits of Health Savings Accounts (HSAs) and how you can use them to reduce your taxes paid.
A Health Savings Account (HSA) is a type of savings account that:
Allows individuals to set aside money on a pre-tax basis
Provides funds for qualified medical expenses.
Allows for investment of HSA funds.
HSAs are available to individuals who have a high-deductible health plan (HDHP). A HDHP is a health insurance plan with a
Higher deductible
Lower monthly premiums
Most employers will label their plan as HDHP. You can't use an HSA if you have Medicare or are a dependent on someone else's tax return.
Contributions to an HSA are tax-deductible, meaning that individuals can reduce their taxable income by the amount they contribute to their HSA. Employers may offer a contribution to the HSA or may allow an employee to defer a portion of their paycheck directly into the HSA.
2024 Contribution Limits for Health Savings Accounts
| Coverage | 2024 Contribution Limit | Add Catch Up if Age 55+ |
| Individual | $4,150 | $1,000 |
| Family | $8,300 | $1,000 |
Funds in an HSA can be used to pay for:
Doctor visits
Prescription medications
Hospital stays
Premium payments for COBRA or Long Term Care (subject to limits and exclusions)
It's important to note that HSA funds can only be used for qualified medical expenses and may be subject to penalties if used for non-qualified expenses.
Distributing HSA funds for non-qualified expenses can potentially result in a 20% penalty on top of income tax.
One of the main benefits of an HSA is the tax advantages it offers compared to other types of savings' accounts.
| Tax Deduction | Tax-Free Growth | Tax-Free Distributions | |
| Health Savings Account (HSA) | |||
| Roth IRAs | |||
| IRAs |
Contributions to an HSA are tax-deductible, which means that individuals can reduce their taxable income by the amount they contribute to their HSA. This deduction shows up as adjustment to income under line 10a on the 1040.
Contributing the maximum HSA family contribution for 2024 of $8,300, would save ~$3,000 in federal income tax at the 37% tax bracket.
Additionally, any interest or investment earnings on HSA funds are tax-free, allowing the account to grow and accumulate savings over time.
Withdrawals from an HSA for qualified medical expenses are also tax-free, providing individuals with a tax-free way to pay for their healthcare needs.
The tax benefits of an HSA can result in significant savings for individuals, especially those in higher tax brackets.
Funds in HSA accounts do not need to be spent by the end of the year and can be carried forward into future year. You can also keep the HSA if you leave an employer.
Individuals can also use it as a savings account for future healthcare expenses.
By contributing the maximum allowed amount to their HSA each year, individuals can build up a substantial savings account to cover future healthcare costs.
For individuals who have accumulated a large HSA balance and do not anticipate needing all the funds for medical expenses in the short term, there is an opportunity to invest the HSA funds for long-term growth.
Investing HSA funds for long-term growth can provide clients with an additional source of retirement income or a nest egg for unexpected medical expenses in the future.
Based on the latest Fidelity Retiree Health Care Cost Estimate, it is estimated that at age 65, the average retired couple would require a substantial $315,000 saved specifically for covering their healthcare expenses.
If you are 30 years old today, the $315k in 2023 estimated healthcare expenses will inflate to $1.7M in 2059 (assuming 5% healthcare inflation).
Let's compare three different approaches to saving for healthcare expenses in an example:
| Annual Contribution Limits1 | Account Investment Growth / Year | % of Saved Healthcare Costs at 65 years old | |
| Contribute AND Invest in HSA | $8,300 | 7% | 100% |
| Contribute to HSA and NO invest | $8,300 | 0% | 29% |
1) Assumes contribution limits increase at 3% / year.
As you can see from the above, using an HSA to save AND invest provides a very tax efficient method for covering retirement health care expenses.
The below HSA strategies are more advanced in complexity and execution but provide additional tax and estate benefits. I've linked helpful resources for further investigation and would recommend reviewing each approach with your tax advisor before implementing.
This strategy involves paying for medical expenses out of your normal living expenses rather than withdrawing funds from your HSA. You would scan/store the healthcare invoices or receipts for the future when you needed funds from your HSA.
Distributions from your HSA can cover qualified expenses from prior years while your HSA was open.
Example:
Our family incurred a $12,000 bill for a medical procedure in 2023
I chose to use personal (non-HSA) money to pay for the procedure
I still decided to contribute the maximum to my HSA in 2023
I invested the HSA money in 2023 and now it is worth $20,000 in 2030
I could use my $12,000 medical receipts to withdraw funds tax free in 2030 because the procedure is a qualifying expense and I had an HSA at the time of the procedure
Another lesser-known benefit of HSAs is the ability for anyone to make contributions to another person's HSA. For instance, a parent can contribute funds to their child's HSA, which can then be utilized for healthcare expenses or long-term healthcare savings.
Given that children can now stay on their parents' health insurance plan until they turn 26, non-dependent children under a family HDHP have the opportunity to contribute to their own HSAs. For example, a newly graduated child in their first job could contribute up to $8,300 (family limit in 2024) to an HSA while they are on their parents' health insurance.
HSA funds can be versatile in covering various types of health insurance premiums. For example, HSA funds can be used to pay for long term care premiums subject to certain limitations. This strategic use of HSA funds not only provides peace of mind but also maximizes the tax advantages of the account, allowing for tax-free withdrawals to pay for essential long-term care insurance. It's important to consult with a financial advisor to understand the specific limitations and guidelines for using HSA funds for long-term care premiums.
Non-spouse inheritors of HSA accounts must pay the income tax on the HSA account soon after death. Therefore, it is important to think about ways to utilize or distribute the HSA funds during the life to avoid a costly tax surprise. This is especially important as HSA accounts may grow to substantial values over time.
In conclusion, Health Savings Accounts offer individuals a valuable opportunity to save for future medical expenses while enjoying significant tax benefits. By maximizing contributions, investing for long-term growth, and utilizing advanced strategies, individuals can secure their financial well-being and ensure they have the necessary funds to cover healthcare costs. It's important to explore all the possibilities and consult with a financial advisor to make the most of your HSA account.
Sources:
Kitces, M. (2022, November 9). Maximizing Health Savings Accounts (HSAs) Tax Benefits With Adult Children Under Age 26. Kitces.com. Retrieved from.
Kitces, M. (2016, January 20). Retirement Health Savings Account And Medicare: Supplemental Saving In An HSA For Retiree Medical Expenses. Kitces.com. Retrieved from.
Kitces, M. (2023, February 15). The HSA ‘Deathbed Drawdown’: Making Tax-Efficient Distributions Of Large Balances (When There Isn’t Much Time). Kitces.com. Retrieved from.
Internal Revenue Service. (2023). Publication 969 (2023), Health Savings Accounts and Other Tax-Favored Health Plans. IRS.gov. Retrieved from.
Disclosure