What is a Health Savings Account (HSA)? It’s Like a Health Care IRA
HSA tax benefits aren’t commonly spoken of, but worth looking into. I believe that one of the most interesting investment vehicles for tucking away money is a Health Savings Account. Not everyone has heard of these accounts, but they are similar to individual retirement accounts (IRAs), but provide even more tax benefits. Proponents of HSA’s call this a “triple tax free” structure. The important caveat on these accounts is that the money in the account needs to be spent on qualified health care goods and services (which is pretty easy to do these days) or it is subject to additional taxes and fees.
Triple Tax Benefits in a HSA
First, you can deduct your annual contribution on your personal tax returns. Second, the capital can be invested and it compounds tax free in the account (just like an IRA). Third, if the account owner withdraws money to spend on a qualified healthcare expense, it is not taxed. This is an extraordinary advantage for tax benefits and is worth quite a bit of money to most people.
Let me illustrate in a couple of scenarios.
- Long-Term Investors: John and Sally are 30 years old and have an HSA for their family. They plan to contribute $6,750 a year to this account until they are 65. Since they view this as a medical savings account that they will tap into when they are 65, John & Sally choose higher risk/higher return investments (+7% annually), due to the very long investment time horizon for the account. In 35 years, this account will be worth over $900,000 (about $375,000 – $400,000 in 2017 $ after adjusting for 2.5% annual inflation). Current thinking is that health care expense will average $250,000 during retirement for most couples – so John & Sally look to be well covered. During retirement, the couple would plan to pay all of their health care expenses out of this account, as they will not pay taxes on the withdrawals.
- Short-Term Investors: Sam and Freddy are 55 years old and have an HSA for their family. They will contribute $7,750 to their HSA account ($6,750 + $1,000 for people over 55 years old) for the next 3 years. Since they have an active son who is prone to skateboarding injuries, the couple elects to invest the money at a low risk/low return investment profile (+3% annually), as it is very likely they will need to tap into the savings some time in the near future. In 3 years, when their son has skateboarding accident that requires out-of-pocket health care expenses, the account is worth nearly $24,000.
- Near-Term Tax Savings: Derek is a single man who had $3,000 in out-of-pocket healthcare expenses last year due to a skiing accident. Derek can contribute $3,400 into his new HSA account this year and immediately pay himself back for prior year medical expenses. Since Derek is in the 33% Federal Income Tax bracket, he saves $1,122 in taxes this year by structuring his medical savings this way.
Should I Open a Health Savings Account (HSA) for Tax Benefits?
It depends. HSAs take some discipline to fund annually. Picking the right investments can be tricky, since the time horizon on when you will need the money is unpredictable (therefore it will take a much different strategy than retirement assets). Certain HSA platforms have high fees, which may eat into the tax benefits you are working so hard to capture. Finally, HSAs, by definition, are high deductible health care accounts. Therefore, if you incur major health care expenses in the near term, you may not have the resources to cover your immediate needs, which may leave you in a tough spot.
Still unsure? I’m happy to be a sounding board for your questions on this tricky topic. Just give me a call – 206-281-4055.
