Getting Ahead of the Pack with Health Saving Accounts

You may be asking,

Why hasn’t a site dedicated to high income earners featured a post on Health Savings Accounts yet?

Well, you wait is over. There is a lot of good information out there about HSA’s and how they work. With this article, I want to show you some of the advantages and how HSAs can help you save for the future and defer some taxes.

First some basics

Health Savings Accounts came into existence during the Bush 43 administration. The precursor, called an Archer MSA (medical savings account), was developed in the 90’s when the Health Insurance Portability and Accountability Act (HIPAA) became law. Those MSAs were only for the uninsured, self-employed or small business owners with 2-50 employees. These type of accounts caught on and President G.W. Bush promised to expand the program.

HDHP

HSA’s were born in 2004 and have been flourishing ever since. HSAs go hand in had with High Deductible Health Plans (HDHP). In order for a plan to qualify as an HDHP, it must meet these criteria.

  1. Any health plan with a deductible of at least $1,300 for individuals and $2,600 for families.
  2. The plan can’t have a yearly out of pocket expense of more than $6,550 for individuals and $13,100 for families.
  3. This doesn’t include out of network costs but does include copayments, deductibles, and coinsurance.

The maximum you can contribute to an HSA is $3,400 for an individual and $6,750 for a family in 2017. If you’re over 55, you can contribute an extra $1,000 for catch up purposes.

Contributors can use HSA funds on almost anything medically related. Some notable exceptions are nonprescription over the counter drugs and health insurance premiums. COBRA premiums are eligible, as well as insurance premiums while you are claiming unemployment benefits.

You also have to have an HDHP in place before you can fund a medical expense with an HSA. For example, you can’t receive medical care in January, start your HDHP and HSA account in March and then fund the bills from your January medical expense. This is an excellent worksheet to give you the ins and outs of what can be funded with an HSA.

Triple Tax Threat

For high income earners, this is the holy grail of tax deductible plans. HSA contributions come out pretax. That means when you put in the whole $6,750 for a family that could be up to a $2,673 in federal tax savings if you’re in the highest bracket.

Some states allow state income tax deductions as well but they’re all state specific. For example, California doesn’t allow an income tax deduction so make sure to check your state’s tax rules for HSA contribution deductions.

The best part is many HSA plans allow an investing option. These investments grow tax-free as well. In my Optum Bank plan, the Vanguard S&P 500 Index fund is available. I invest in that since it has a very low expense ratio.

Third, as long as the account holder uses the money for a qualified medical expense, there is no tax when it comes out of the account.

Strategy

A strategy that some high earners use is to max out their HSA’s, save the receipts and then pay all current medical expenses from other income sources (usually your checking account). By saving the receipts, these expenses can by funded by the HSA at a later date. The later date could be 40 years away. As you can see, this could be pretty lucrative. Read on to the end to see how.

For instance, say you save the full $6,750 a year for 20 years from age 25-45 and then stopped contributing. That is $135,000 in principle alone. If you averaged a 7% return on that money until age 65, you then have $1.2 million in your account. That is a pretty good insurance policy for medical costs into your old age, not to mention a bigger retirement plan than most American’s accumulate.

Some folks even proclaim quadruple tax saving because employer contributions are pre-medicare/social security tax. This usually isn’t the case entirely for high income earners because we earn over the maximum amount for social security at $127,200. For the Medicare portion, we could still save another 2.9% or $195.75.

 

Life Starts at 65, at least for HSAs

Once you reach age 65, there are a few perks when it comes to HSAs. Even if you don’t use all $1.2 million on medical expenses from the example above, after age 65, the IRS taxes the funds at your regular income rate for nonmedical expenses. Effectively, the HSA works like a traditional IRA at that point.

If you take out funds from an HSA (also called a distribution) before age 65 to use on nonmedical expenses there is a 20% penalty in addition to your top tax bracket rate.

Once you are over 65, Medicare premiums Part B, Part D, and Medicare Advantage are payable with HSA funds.

Tax Savings Might Make your Health Plan more Affordable than you Thought

HSAs can be a big factor in choosing your health insurance plan. I’ll take you through my own example and what I have access to from my employer.

For my company HDHP, our current family premium is $1,100 a month. I can contribute to an HSA and all this money is pretax.

That comes out to a total cost of $19,950 for my health care cost for the year. The plan has a $5000 deductible.

When you look at the tax savings of all that coming out pretax, my actual cost is $11,471. That drops my premium down to $955 per month and I still have access to the $6750 if I need it. I also can invest it and really make it grow. If we used that example from above where I invested that $6,750 for 20 years and ended up with 1.2 million, my cost over that 20 years was only $229,425.

I know I’m leaving out the variable of how much deductible I would use and if the investment would really perform that well, but I mainly wanted to show you how the HSA could be a very powerful tool.

If you aren’t fully contributing to an HSA, you could be missing out on huge tax saving.


 


So, do you like HSAs? Do you think they are useful? Is it hard to save that money or do you find yourself dipping into the HSA funds like a most other Americans?

 

 

 

 

Tom
Tom is a doctor, husband and father of five with a passion for parenting and finance. When he isn't skateboarding, riding BMX, or jumping on the trampoline with his kids, he is reading and writing about personal finance. He helps high income parents educate and mentor their kids to become financially, emotionally, and intellectually self sufficient.

6 Responses to “Getting Ahead of the Pack with Health Saving Accounts

  • I started contributing to HSAs this year. I pay for medical expenses as I go along and take tax-free withdrawals. It’s simpler (albeit financially suboptimal) to keeping your receipts and withdrawing that money in retirement.

    • It’s definitely a commitment to keep the receipts. I guess they would only come into play if you got audited but as shown by the math it could add up to a big pot for medical purposes with compounding.
      Needless to say, we all have to pick our battles and you are still getting a nice tax deferral while you are in your high earning years.

      Tom @ HIP

  • I don’t have access to an HSA but an FSA through work. Unfortunately it’s use or lose so I haven’t taken advantage of it like I should but if I ever plan an elective surgery like LASIK I definitely plan to take advantage 🙂 Thanks for sharing!!!

    • It’s always a tough when the employer doesn’t offer an HSA, but you are probably getting a great deal on your health insurance anyway so its a balance. If you had to price out insurance on your own and have access to an HSA then I bet it would still be more expensive so it pays to go with your employer insurance. Especially with you have a couple kids in the past few years, if you have maternity then that is a great benefit.

      Tom @ HIP

  • Dood, el Farbe
    4 months ago

    Haha, I looked and found my employer does offer an HSA. Unfortunately (the “ha-ha” part):

    Please note: You may see references to “pre-tax contributions” in the Provider’s HSA content – this option is not available to (your employer’s) employees. Only after-tax contributions made by you are allowed to fund your HSA.”

    So I’m thinking, “Why do they even bother to offer this?”

    I can’t see any advantage to opening this account. With the above limitation it’s now no different (from a beneficial side) than any other post-tax investment account. And more negative from the standpoint that there are limitations on my use until age 65.

    • I’m sorry to hear that.
      I guess if you are looking for more tax deferred space, it works like another Roth IRA if you use it for medical expenses. That could be worth it for some people.

      Tom @ HIP

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