What is a HSA, otherwise known as a health savings account?
My colleague Holly Thomas CFP® wrote about HSAs a while back, here is a link to her post. Reading her post reminded me to write a post myself for my followers. This is awesome stuff, so pay attention.
A HSA, or health savings account, is a tax advantaged account used in conjunction with a high-deductible health plan, HDHP. As usual, the details are numerous and tiring, but worth it…
With a HSA, you can put away up to $3,400 this tax year for an individual and $6,750 for a family, and claim an income tax deduction just like with an IRA. If you happen to be 55 or older, you can add another $1,000.
For 2017, the IRS defines a High Deductible Health Plan, HDHP, for an individual as a plan with an out-of-pocket maximum of $6,550 and a minimum deductible of $1,300. For a family plan in 2017, the out-of-pocket maximum is $13,100 and the minimum deductible is $2,600.
You have to have a HDHP to contribute to a HSA. But, you can use the dollars inside your HSA at any time for qualified medical expenses whether you have a HDHP or not.
The downside of HDHP plans is they typically offer no co-pays or other reimbursements before your deductible is met. So, for folks that have ongoing medical issues, they might not be a good fit. But, for generally healthy folks who don’t go to the doctor often, they might be made to order.
HSAs are also are a bit of a conundrum in that they work marvelous for young people. The reason they are so marvelous for young people is the power of compound interest. If you can pay for most of your medical expenses without using your HSA, and let those contributions mount and grow over 20, 30 or 40 years, you will be blown away at how much money will accumulate in the account. The conundrum comes in because young people typically have kids, which typically necessitates frequent trips to the doctor.
See what I am getting at with details and tiresomeness? Hang in there.
Now, for the good stuff…
If you have an employer that offers HSA plans and you can contribute to one via payroll deduction, your contribution is not subject to FICA, which is Social Security and Medicare. That is an additional 7.65% savings to you.
Unlike FSAs, or flexible spending accounts, your contributions never go away. There is no “use it or lose it.”
Next, let’s say, as a family, you can put away $4,000 a year for 10 years, and only use $1,500 a year for medical expenses. You are 35. If you can earn an average return of 7% over 30 years, your net contributions of $25,000 will be worth $143,000 at age 65. If you can let it grow another 10 years, it will be worth $281,340. This is power of compound interest.
It gets better. Once you turn 65, you can use the money inside your HSA for anything. If it is not for a qualified medical expense, which encompasses federal vastness and is completely tax-free, you only pay ordinary income tax on the distribution, there is no penalty. So, it provides another avenue to save for retirement outside of an IRA, a Roth IRA, a 401k, a pension plan and the like. It’s another tool in the tool box that many people overlook.
Once you pass away, your HSA can be inherited by your spouse tax free. It will then be treated as if it is their HSA. Once the spouse passes away or if your beneficiary is not your spouse, the HSA value becomes taxable in full as of their or your death.
Don’t over look HSAs. To learn more, contact my friend Holly, me or any fee-only CFP®.