Health Savings Accounts Demystified – Just in Time for Tax Filing

We’ve all heard of a 401(k) – the majority of us have them.  How many of you have heard of a Health Savings Account (or HSA, for short)?  Or even better, how many of you know the in’s and out’s of an HSA? This special type of account can be a really great way to save in a triple-tax-advantaged way for healthcare-related expenses now and in the future.

If you have access to a high deductible health plan, listen up. If you don’t currently have access to health plans that include HSA options, keep an eye out for it in the future.  Depending on your personal situation, using an HSA may be worthy of your consideration.

 

The Basics

An HSA is a savings and investment account that can be used to reimburse eligible medical expenses – like doctor visits, prescriptions, or vision / dental expenses.  But it’s different than a traditional savings account in three ways:

  1. Your contributions to the account are tax-deductible
  2. Growth and income are tax-free
  3. Withdrawals are tax-free when used to pay for eligible healthcare expenses

Voilà, this is why an HSA is referred to as “triple-tax-advantaged” and can be a great compliment to savers out there that are also putting money into their retirement plans.  It effectively means we can save more in aggregate if we use a multiple account approach to funding our long-term expenses (in addition to your 401(k)) – especially with healthcare costs being a large component of spending as we age.

An important reminder – Health Savings Accounts (HSA’s) are not to be confused with Flexible Spending Accounts (FSA’s) offered through employers.  An HSA carries over from year-to-year and belongs to the individual unlike the FSA.

Now that we’ve got that straight, let’s work through a couple of scenarios.  While the annual contribution limits don’t come close to 401(k) contribution limits the triple-advantaged status of a disciplined savings strategy over 10-20 years, can really pay off!  The contribution limits for 2020 and 2021 are:

2020 2021
Single  $                    3,550  $                    3,600
Family  $                    7,100  $                    7,200
Catch Up (55+)  $                    1,000  $                    1,000
Maximums include Employer contributions

OK – great.  So now we know what the annual limits are, what can we do?  We get questions all of the time about how much folks are eligible to contribute annually – and well, that depends on the individual / family coverage situation.

 

Here are a few sample use cases using 2021 IRS limits

Scenario 1 All participants covered as family on Spouse 1 (55+) health plan
Spouse 1 Spouse 2 Child* Total
Family / Single                   7,200                   7,200
Catchup (Age 55+)                   1,000                   1,000
Total Eligible Contrib.                   8,200                         –                           –                     8,200
Scenario 2 Both spouses have separate health plans (55+) with HSA
Spouse 1 Spouse 2 Child* Total
Family / Single                   3,600                   3,600                   7,200
Catchup (Age 55+)                   1,000                   1,000                   2,000
Total Eligible Contrib.                   4,600                   4,600                         –                     9,200
Scenario 3 Have young adult child on family plan but they file own tax return
Spouse 1 Spouse 2 Child* Total
Family / Single                   3,600                   3,600                   7,200                 14,400
Catchup (Age 55+)                   1,000                   1,000                   2,000
Total Eligible Contrib.                   4,600                   4,600                   7,200                 16,400
* child not claimed as dependent on parent tax return

Given the various situations that may arise, like the above, we recommend consulting with your financial or tax advisor to review your specific situation.

Regardless of the amount you are eligible to contribute, HSA’s are a great way to save for today’s healthcare expenses and invest over time much like you add to retirement accounts.  By setting up an entirely different bucket for healthcare expenses, you can minimize the impact on your other retirement savings vehicles.

If you want to sock away as much as you can in a tax-efficient manner, don’t overlook the value of an HSA and its role in your long-term financial plan.