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What are Health Savings Accounts (HSAs) and should I have one?

October 11, 2023 | By Matthew Gordon, CFP®, RLP® and Tim Daly, CPA with contributions from our interns Maya Monsour and Rohan Sagar
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Health Savings Accounts (HSAs), as the name implies, are savings accounts for health care expenses. There are restrictions on who may contribute, how much, and what counts as a qualified medical expense. It is worth exploring whether you have the opportunity to participate in one of these accounts as they provide some compelling tax benefits.

What are the tax benefits of HSAs?

HSAs are tax-favorable in 3 ways:

  1. Contributions to an HSA are tax-deductible
  2. Earnings within an HSA grow tax-free
  3. Withdrawals for qualified medical expenses are tax-free

Who is eligible to contribute?

To be eligible, you must participate in a medical plan that covers certain preventive services and it must be a “High Deductible Health Plan” (HDHP). To be a HDHP, the plan must carry an annual deductible of at least $1,500/$3,000 (individual/family) and out-of-pocket maximums of $7,500/$15,000 (2023 figures that are indexed for inflation). You are ineligible if you are:

  • Covered by Medicare
  • If you (or your spouse) participate in a Flexible Spending Account
  • Or, claimed as a dependent on another person’s tax return.

How much can I contribute to an HSA?

In 2023, the contribution limits to an HSA are $3,850 for individuals and $7,750 for families. If you’re over 55, you can make an additional $1,000 catch-up contribution. Contributions for 2023 can be made up until the tax filing deadline (April 15, 2024).

The IRS recently released the HSA contribution limits for 2024. These new limits include an increase of $300 for individuals to $4,150 and $550 for families which will allow them to contribute $8,300 in 2024.  

How do I establish an HSA?

You can create an account with a qualified HSA trustee (typically a bank, brokerage firm or insurance company). There may also be an HSA plan available through your medical plan at work and your employer may even make contributions to the plan on your behalf as an added incentive to participate. If you make contributions through your employer, you may be able to avoid payroll taxes on the funds contributed. Even if an HSA is through your employer, the account belongs to you. HSAs are portable and you can use the funds at any time; there is no annual use-it-or-lose-it as with a flexible spending account.

Whom should I choose as an HSA provider?

Factors to consider would be service, convenience, flexibility and fees. Some HSA providers issue debit cards or checkbooks to make the withdrawal process simple. If there is a provider through your employer, it may be a good idea to default to that option given the payroll tax savings mentioned above.

What is a “qualified medical expense”?

Qualified medical expenses are generally those costs associated with your medical and dental care and are not reimbursed from another source (i.e., not covered by insurance). The expense cannot also be taken as an itemized deduction. Some non-traditional expenses may qualify such as home improvement and transportation costs due to a medical event. A portion of your long-term care premium may also count as a qualified medical expense.

What if I take a withdrawal for non-qualified reasons?

Non-qualified distributions are subject to ordinary income tax and a 20% penalty. If you’re 65 or older, you are not subject to the 20% penalty but still would be subject to income tax.

How do I report my HSA activity?

You must file Form 8889 if there were any contributions to (including employer contributions) or distributions from your HSA during the year. You can also pay yourself back for medical expenses in later years if you keep the receipts for those medical expenses paid for through normal cash flow. This would allow your HSA funds to enjoy more compound growth by leaving the account untouched in early years and simply paying yourself back in the future.

What happens to my HSA when I die?

If your spouse is the named beneficiary, they get to treat the HSA as their own. Otherwise, the HSA will cease and will be includable as taxable income to your non-spouse beneficiary (or to the estate if no beneficiary is named). For this reason, it is important for a married account holder to name their spouse as the beneficiary.    

Can an HSA help me in retirement?

The two biggest expenses for most people in retirement are taxes and health care. It’s estimated that the average person spends about $315,000 on healthcare during their retirement. This can be a daunting figure, especially if you don’t start saving early. Due to the triple tax benefit of HSAs mentioned earlier, they are one of the best vehicles for saving for healthcare costs in retirement. If you contributed and invested the maximum family amount to your HSA every year ($7,750) for 20 years you could have over $350,000. If you started saving even earlier and contributed for 30 years, you could have over $875,000 (These figures are based on an 8% annualized return).

Can I make HSA contributions for my children?

In some cases, you may be able to make the full family maximum contribution to an HSA for your child ($7,750 in 2023), in addition to funding your own.

What makes your child qualify?

  • Covered under parents’ High-Deductible Health Plan (HDHP)
  • Not enrolled in Medicare
  • Not claimed as a dependent on someone else’s tax return
  • Earned income is not necessary

Your children can remain on your healthcare coverage up to the age of 26, which makes this a great opportunity to gift to your kids in their early working years. In this scenario you would be able to contribute $7,750 for your own HSA and for each of your children. Making these gifts early can set them up for success in life and retirement when medical expenses arise.

Even if this specific situation doesn’t apply to your family, funding and HSA could still be a great gifting opportunity for your children. You could simply reimburse them for contributing the max single amount ($3,850 in 2023) which over time can grow a significant amount.

There are many more questions that one could ask about HSAs and the rules can get quite complex. For more information, see Tax Secrets of Health Savings Accounts. For a detailed description, see IRS Publication 969. To learn more about how HSAs can fit into your wealth-building strategy, schedule a free consultation with a Wealthstream advisor today.

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