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Health Savings Accounts: A super-powered “unicorn” container for accumulators and decumulators

Senior Wealth Advisor Bronwyn Shone, CFP® shares the many advantages to a Health Savings Account (HSA).

In a recent blog, “Contain Yourself! The tax treatment of different account types and why account structure matters,” we discussed account types according to their tax characteristics: taxable, tax- deferred, or tax-free. Health Savings Accounts (HSAs) combine characteristics of both tax-deferred and tax-free accounts: funds going into an HSA are tax deductible, they grow tax-free and withdrawals are tax-free if the funds are used for qualifying medical expenses. If used properly, these accounts are triple tax exempt, making them rare and valuable.

Health Savings Accounts must be used in conjunction with an HSA compatible health plan, and the plan must have a high deductible as defined by the IRS. The accounts are often offered by an employer but should not be confused with Flexible Spending Accounts (FSAs) which have “use it or lose it” rules. If you buy your health insurance on the exchange, you can still participate in an HSA by choosing an HSA-compatible health care plan. (Usually, such plans include the terms “HSA” or “Savings” in their names.) Health Savings Accounts are owned by the investor and are therefore completely portable, without “use it or lose it” rules, and funds that aren’t used are rolled to the next year. Note that you can’t contribute to both an HSA and an FSA in the same year unless the FSA is considered “limited purpose.”

Much like IRAs and Roth IRAs, there are limits to how much you can contribute to your HSA, though unlike IRAs and Roth IRAs, contributions are not limited by your income. Current annual limits are $3,400 for an individual and $6,750 for a family. Catch up contributions of $1,000 are allowed for those age 55 or over.

If your employer provides a health savings account to accompany its HSA compatible health plan option, you may want to choose it as a default to ease paperwork burdens. If you buy an HSA compatible health plan on the exchange, you are free to shop around for a provider. Online and brick and mortar banks and credit unions are good places to start, and you’ll want to consider account fees, including check processing and other fees, when making your decision.
How do you use an HSA? HSA providers give you a checkbook or debit card, and you use these for qualifying medical transactions (but not insurance premiums). Given the contribution limits, it is quite possible to use up the funds you’ve contributed if you have a medical event in the year of contribution. After a few years of contributions, and some good luck with your health, you will eventually grow a balance in your HSA that likely exceeds your out-of-pocket maximum. That is when things can get interesting for an HSA owner. Some HSA custodians allow you to invest in mutual funds, and if you are an accumulator with a long time horizon, this can be an attractive place to grow your account balance for future health care needs.

And if you are 65 or older? Account holders who are 65 and older can use their HSAs for any expense, though they will pay ordinary taxes on withdrawals used for non-medical expenses, which simply regresses their HSA to an IRA type of account (but without required minimum distributions). Note that participating in any type of Medicare (Parts A, B, C or D) disqualifies you from contributing to an HSA. A boost for those over 65, however, is that they can use HSA funds to cover some portions of their Medicare premiums.

HSAs can be used to pay short-term medical expenses, but can also be used as a source of long-term savings for health expenses incurred later in life, and to hedge against an uncertain future regarding medical costs.

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