The taxman seems to follow us everywhere, right? He taxes our salaries, our properties, our purchases, our investments, and even our gifts! It’s hard to find a place where his hands don’t reach. However, there is one bastion of tax-free goodness potentially available to you. Imagine drawing a salary, not paying taxes on a portion of it, placing that portion into a special account, purchasing investments within that account, collecting interest and dividends tax-free, selling those assets for a profit, and withdrawing and spending your new funds without paying a dime in tax. Yes, it’s possible! In fact, about 35 million Americans already take advantage of it.
Ok, what is this seemingly miraculous account? The Health Savings Account!
History of the Health Savings Account
The Health Savings Account (HSA) was established as part of the Medicare Prescription Drug, Improvement, and Modernization Act, signed into law by President George W. Bush on December 8, 2003. The primary goal of HSAs was to help individuals covered by high-deductible health plans (HDHPs) save for medical expenses on a tax-advantaged basis. Since its inception, HSAs have grown in popularity due to their triple tax advantages and flexibility in covering a wide range of medical expenses.
Tax Benefits of HSAs
Did the phrase ‘triple tax advantages’ pique your interest? It should! This is the magic sauce that makes them one of the most attractive savings vehicles available and enables you to avoid giving a dime to Uncle Sam if you follow the rules and regulations set out by the IRS.
Tax-Deductible Contributions: Contributions to an HSA are tax-deductible, meaning they reduce your taxable income for the year. You could even drop down a tax bracket for the year, leading to greater tax savings and potentially more money for investing.
Tax-Free Growth: After contributing a portion of your salary to your HSA, you can now purchase assets that align with your risk profile, such as mutual funds, ETFs, stocks, and bonds. You can then collect interest, dividends, and profits by selling off assets that have appreciated in value without claiming those gains on your tax returns on an annual basis, reducing your tax drag to zero.
Tax-Free Withdrawals: Finally, you can withdraw funds as necessary to spend on medical expenses without paying any taxes. If you spend your funds on anything but qualified medical expenses, you’ll owe tax and a penalty.
Additional HSA Benefits
While the primary benefits of an HSA include tax-deductible contributions, tax-free growth, and tax-free withdrawals for medical expenses, there are other advantages that make HSAs a valuable tool in financial planning:
Portability: HSAs are not tied to your employer. If you change jobs or leave the workforce, your HSA funds remain with you, providing continued access to your savings.
No Use-It-Or-Lose-It Rule: Unlike Flexible Spending Accounts (FSAs), HSA funds roll over from year to year. You don’t have to worry about losing your money at the end of the year.
Spousal Contributions: If both you and your spouse are eligible for an HSA, you can each contribute to separate accounts, maximizing your family’s tax-advantaged savings potential.
Contribution & Eligibility Rules for HSAs
The prospect of an HSA may sound appealing, but you won’t get to open and contribute to one if you aren’t enrolled in a high-deductible health plan (HDHP), which is defined as a health insurance policy with an annual deductible of at least $1,600 for self-only coverage or $3,200 for family coverage. Additionally, the annual out-of-pocket expenses, which include deductibles, co-payments, and other amounts but exclude premiums, must not exceed $8,050 for self-only coverage or $16,100 for family coverage.
The contribution limits for HSAs are set annually by the IRS.
As of 2024, the contribution limits are as follows:
| Coverage Type | 2024 Contribution Limit |
|---|---|
| Individual Coverage | $4,150 |
| Family Coverage | $8,300 |
| Catch-Up Contributions | Additional $1,000 annually for individuals aged 55 and older |
CPA Quick Facts: Employers, employees, and other individuals can contribute to an HSA, and contributions can be made through payroll deductions, direct deposits, or transfers from other accounts. As an employer, you can deduct contributions to your employees’ HSAs as a business expense.
Withdrawal Rules for HSAs
Withdrawals from an HSA are tax-free ONLY if used for qualified medical expenses. Fortunately, the list of qualifying expenses is extensive.
Eligible Expenses for HSAs
| Eligible Expense | Description |
|---|---|
| Medical Services | Doctor visits, hospital stays, surgeries, and diagnostic tests. |
| Prescription Medications | Costs for prescribed drugs and insulin. |
| Dental and Vision Care | Exams, treatments, and corrective lenses. |
| Preventive Care | Vaccinations, screenings, and wellness check-ups. |
| Long-Term Care | Services and insurance premiums for long-term care. |
| Other Expenses | Medical equipment, supplies, and transportation related to medical care. |
PRO TIP: Be sure to keep detailed records of your medical expenses and HSA withdrawals to ensure compliance with IRS regulations.
After age 65, withdrawals for non-medical purposes are subject to income tax but no penalty, transforming your investment account into a potential retirement tool. At this point, it basically can operate as an IRA or HSA, depending on how you spend your funds. For individuals who do not qualify for deductible IRA contributions because they have a workplace retirement plan and their income exceeds certain limits, an HSA can serve as an additional tax-advantaged retirement account to help supplement your retirement savings goals and provide greater tax diversification in retirement.
When and How to Use an HSA
An HSA can be incredibly beneficial, but it might not be suitable for you. Before you run off to open one, first ask yourself these questions:
Can you afford the high deductible of an HDHP and generally higher out-of-pocket expenses? If yes, great – if not, perhaps you should seek alternative solutions, especially if you have frequent visits to the doctor or ongoing medical issues. Your costs could outweigh the benefits.
Do you have the risk tolerance necessary to invest? Investing is inherently risky, and there’s no guarantee that you will earn money or that you will be able to sell your investments for a profit when you want to make a withdrawal to pay for a medical expense.
Are you comfortable managing your own healthcare expenses? An HSA requires you to take an active role in managing your healthcare costs, including tracking your medical expenses and ensuring they qualify for tax-free withdrawals. If you prefer a more hands-off approach, an HSA might not be the best fit for you.
Do you plan to save for future medical expenses? One of the main advantages of an HSA is the ability to save and invest money for future healthcare costs. If you primarily need funds for immediate medical expenses, you might not fully benefit from the long-term savings potential of an HSA.
In Conclusion
As we can see, there are a lot of maybes when it comes to the HSA. But if you can check all of the appropriate boxes when it comes to eligibility requirements and overall suitability, the HSA can be quite the gamechanger for your personal financial plan. Alternatively, if you have your own accounting practice, an HSA may improve the happiness, health, and hustle of your employees.
Do you want to see if an HSA is in the cards for your financial situation? Reach out today to a CPA Retirement Solutions specialist. Our team is dedicated to helping CPAs navigate their financial planning needs, ensuring you make the most of your savings and investment opportunities. Click the button below to get started on your path to a more secure financial future!
