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Are you getting the most out of your Health Savings Account?

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Learn why HSAs are the new retirement account

Updated May 9, 2024

Health Savings Accounts (HSAs) have become prominent as more and more employers are offering High Deductible Health Plans (HDHPs) in an effort to control their health insurance costs. Most employers offer an HSA in conjunction with the HDHP.  The original intent of the HSA was to allow employees to save for a “rainy day” when they need to utilize the healthcare system and have to pay 100% of the costs up to their deductible. But a new trend has been emerging – save in your HSA, but do not use the funds to pay for current medical costs.

Strategies to most efficiently utilize HSA benefits are emerging as the accounts become more prevalent. These unique planning opportunities are available due to the “triple tax benefits” that HSAs provide:

  1. Tax deductible contributions: Contributions to HSAs are tax deductible. Much like contributions to your traditional 401(k) or 403(b) plan, you will pay less in taxes if you contribute to an HSA. The current contribution limits for 2024 are $4,150 for individual and $8,350 for family coverage, with a $1,000 catch up if you are over 55 years old.  
  2. Tax-free growth: Similar to a qualified plan (IRA, Roth IRA, 401(k), etc.), the IRS allows the investments in these accounts to grow tax deferred, meaning there is no tax on any growth and income earned inside the account.
  3. Tax-free distributions: Withdrawals from HSAs are tax-free (much like Roth IRA’s), provided the funds are used for qualified medical expenses.

Because of this triple tax benefit for HSAs, it may be in your best interest to utilize your HSA for long-term savings rather than short-term annual medical expenses. If your cash flow permits, the strategy involves making the maximum allowable annual HSA contribution and avoiding distributions for current medical expenses by paying those “out of pocket” instead. This allows you to maximize the value of your HSA. Most HSA banks and custodians offer investment choices for HSAs. Utilizing these over the long-term can lead to substantial tax-free compound growth. As an HSA grows to large values (potentially in excess of $100,000 over time), it begs the question: how do I get the money out and when?

A publication from Fidelity, “2019 Retiree Health Care Cost Estimates,” estimated that a 65-year-old couple retiring in 2019 can expect to spend $285,000 in healthcare and medical expenses throughout retirement. This would imply that retiring with an HSA account valued at $285,000 is not a crazy notion. As a quick note, Medicare premiums do qualify for reimbursement from your HSA. If you have concerns about growing a large HSA balance and needing funds prior to retirement, consider utilizing a strategy called the “Shoebox Method.”

The premise of this strategy hinges on the fact that the IRS does not currently impose time restrictions on when HSA reimbursements need to be taken. As it stands, a shoebox reimbursement could be made years or even decades in the future. Regulations may change, but as of early 2024, there is no limitation.  The idea is to keep all qualified medical receipts in a figurative “shoebox.” In practice, this could likely be a physical filing cabinet or online document storage for scanned and saved receipts (remember to back it up!). If an unexpected need arises in the future, you have a repository of receipts available to reimburse from your HSA and provide funds, tax-free!

For example, John has been diligently saving and growing his HSA for 5 years. His HSA balance is now over $20,000 and growing. John has been saving all of his qualified medical receipts in a “shoebox,” and those receipts now total $10,000. John suddenly has a non-medical emergency and needs $5,000 quickly, but only has $1,000 in his bank account, and everything else is in his 401k and HSA. Instead of getting a loan or using his credit card, John decides to pull out his “shoebox” and reimburse himself for old medical expenses totaling $5,000. This strategy not only allowed John to maximize the triple tax benefits of his HSA, but it also provided him access to $5,000 of tax-free cash in a time of emergency.

Is it possible to grow your HSA too much? The answer could be “yes”. HSAs are not the best accounts when it comes to efficient estate planning. Leaving an account to a spouse is relatively straightforward. However, if a non-spouse inherits the account, it could become taxable income in the year of your death. The rules vary by state, so consult with your estate planning attorney for more specific guidance. If you do feel your HSA has grown too large, and you’ll have more than you need for medical expenses in retirement, you can take distributions for non-medical purposes after age 65 with no penalty. You will owe tax on these distributions at your marginal tax rate, but the 20% penalty will no longer apply. In this case, the tax treatment would be the same as taking a distribution from your Traditional IRA.

HSAs have evolved beyond their original purpose of saving to offset annual out of pocket healthcare costs related to High Deductible Health Plans (HDHPs) and transformed into useful financial planning tools with the potential for significant long-term benefits. Please consult your financial planner if you’d like to evaluate whether these strategies can work for you.