Are Health Savings Accounts A Good Deal?

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Health insurance is back in the news again. While the American Health Care Act proposed by Congressional Republicans probably faces serious legislative hurdles, it seems likely that health care is in for some major changes over the coming years.

As usual, the politics of the issue are outside the scope of this blog.  Instead, I want to take a closer look at Health Savings Accounts (HSAs), which Obamacare made much more commonplace.  And, any Republican change to the law is likely to increase the prevalence of HSAs going forward.

What is a Health Savings Account?

Health Savings Accounts are savings and investments accounts designed to pay for medical expenses.  Sometimes, employers may choose to make contributions for you as they would in your 401(k).  But more commonly, it’s on you to actively contribute to these accounts.

In order to qualify for an HSA, you need to be enrolled in a High Deductible Health Plan.  These plans have lower premiums, but require you to pay a higher amount of your health expenses than a traditional plan. A discussion of the different types of health care plans probably warrants an entire separate article, but you should confirm you are in a High Deductible Health Plan before attempting to open an HSA.

Using an HSA, you will save each month and use that money to pay for your health care costs, up to your annual limit, when you get sick.

One other important qualification note: in order to have an HSA, you can’t be listed as a dependent on someone else’s tax return.  In other words, if you are living with your parents house or someone else provides you with financial support, you may need to confirm with them whether or not they claim you as a dependent.

How Do Health Savings Accounts Work?

You can set up your direct deposit to contribute a portion of your income directly into your HSA. But, there’s a maximum for how much you can contribute annually.  If you’re single, you can contribute up to $3,400 in 2017.  If you’re married, the contribution limit is $6,750 per family.

Once the money is in your account, you can either keep it as cash, or invest the money in the stock market.  Investing this money is great if you’re planning on using your HSA to cover healthcare expenses in your retirement.  But, if you’re looking for a way to save for short term medical expenses, it’s best to keep your account in cash.  The more risk you take with the money in your HSA, the higher the likelihood that your account could go down in value.

A common misconception about HSAs has to do with how long you can use the money you contribute.  I often hear people cite rumors that you have to use the money you put into an HSA by the end of the year, or it expires.  Simply put, this is not true.  Money you contribute this year carries forward to the following year, and so on.  This can make HSAs a great vehicle to save for your healthcare expenses in the future, even if you’re perfectly healthy today.

And, when you change jobs, you still have access to the account.  Just like a 401(k), when you leave you can either keep your account with your old employer and spend it as needed, or you can open a separate HSA and transfer the money.

But why not just keep your money in a regular savings account?  What’s the purpose of having a separate health care savings account at all? Aside from the fact I typically recommend you have separate savings accounts for each of your savings goals, there’s one key benefit to HSAs that we haven’t addressed yet…

HSAs Come With Big Time Tax Benefits

Simply put, HSAs are one of the most tax efficient savings vehicle out there.  What they lack in flexibility (i.e., you need to use the money in the account on healthcare expenses), they make up for in tax benefits.

Money you contribute to an HSA isn’t taxed when you contribute it.  In other words, every dollar you put into your HSA (up to the annual limit) directly decreases your taxable income for the year.  In this way, these accounts work in a similar way to your 401(k).

But, that’s just the beginning.  Not only are the contributions not taxed, but neither the growth of the investments in your account or your withdrawals are taxed. The only catch is that there’s a tax penalty if you don’t use the money you withdraw on medical expenses.

To recap: money contributed to an HSA isn’t taxed when it goes into the account.  Growth isn’t taxed.  And withdrawals aren’t taxed (if spent appropriately).

Simply put, saving in an HSA is one of the best tax incentives out there.

A New Way To Save For Retirement

One of the most common questions I get from millennials has to do with how to appropriately account for health care expenses when they save for retirement.  With the future of Medicare and Social Security in doubt, our generation needs to do a better job saving for these types of expenses than our parents or grandparents did.

An HSA can be a fantastic way to save for these type of expenses.  If you are relatively healthy now and have low medical costs, consider using your HSA as a retirement savings vehicle to cover your medical costs as you get older.

In other words, treat your HSA the same way you treat your 401(k).  Regularly contribute money each month, and invest that money in a portfolio that aligns with your tolerance for risk and long term growth objectives.  As you get older, shift the investments into a more conservative portfolio.  If you do this correctly, by the time you retire, you’ll have a great source of money to cover retirement medical costs.

But, There’s a Catch

The strategy above is a great one, but only for specific people.  If you are relatively healthy now, HSAs can be a great way to save for retirement expenses.  But, if you have a lot of medical expenses now, this probably isn’t the right strategy for you.

The problem with HSAs for people who have high medical costs goes back to the beginning of this article- in order to have an HSA, you need to have a High Deductible Health Plan.  These plans can sometimes require that you pay $10,000 or more of your medical costs per year before your insurance kicks in to cover your expenses.  If you’re likely to spend a lot on heath care, it might be better for you to opt for a lower deductible health plan and skip the HSA altogether.  Or alternatively, to use the money in your HSA for your current medical expenses, rather than saving it for the future.

In other words, I think HSAs are a great option for most people, but if you have a lot of medical expenses, it may not be the best one for you.  If you’re in this boat, I recommend sitting down and comparing the tradeoff between paying a higher premium for more comprehensive health insurance vs. paying a lower premium with a higher deductible.  Let this analysis drive your decision.

I help my clients make these decisions all the time.  If you need help, give me a call.

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