Health Savings Accounts – a triple tax advantage

How can you ensure you have enough to pay your bills and still be as tax efficient as possible?

Coins and a calculator
Linde Carroll
LINDE CARROLL Sustainable Wealth Management

With rising healthcare costs, how can you ensure you have enough to pay your bills and still be as tax efficient as possible?

That’s where Health Savings Accounts come into play. Established in 2003 as part of the Medicare Modernization Act, Health Savings Accounts (HSA) help individuals with high-deductible health plans (HDHPs) cover qualified healthcare costs. As healthcare costs continue to climb, this has spurred HAS growth. A recent study by the Employee Benefits Research Institute found that some retired couples could need more than $360,000 to cover medical expenses in retirement. With longer lifespans and the uncertainty surrounding what Medicare will look like in the future, HSAs provide a great opportunity to save and manage healthcare costs in retirement.

In addition to managing healthcare costs, HSAs also offer several tax advantages:

  • Contributions are tax-deductible (or pre-tax if the plan is through an employer)
  • The money grows tax-deferred
  • Withdrawals for qualified health expenses are tax-free

Wondering how you can begin taking advantage of this?

In 2019, individuals can contribute up to $3,500 or up to $7,000 for married couples. There is also a $1,000 catch-up contribution for those over 55. Any amount an employer puts into the HSA counts toward the contribution maximum. The contributions remain in your account until you use them. Remember, don’t confuse an HSA with an FSA, or flexible spending account. The two accounts are very different. FSAs are “use it or lose it” meaning the money doesn’t roll over from year to year. Savings accrued in HSAs can remain invested for the long term or may be used in the short term to cover qualified medical expenses.

Funds in an HSA account can also be invested, although the investment choices will vary depending on the HSA administrator. Please note that many plans require a minimum balance — say, $1,000 or $2,000 — before you can begin investing the funds (Schwab).

As a practical matter, it’s a good idea to keep one to three years’ worth of potential out-of-pocket health care expenses in cash or a cash investment (such as a savings account or money market fund) to avoid selling riskier investments in a down market (Schwab).

Eligibility requirements for HSA:

  • Covered under a high deductible health plan (HDHP)
  • No other health coverage except what is permitted under Other health coverage
  • Not enrolled in Medicare
  • Can’t be claimed as a dependent on someone else’s 2018 tax return

Another benefit of HSAs is that they are “portable.” An HSA stays with you if you change employers or leave the work force. However, if you use HSA funds on nonmedical expenses before age 65, you pay not only ordinary income tax but also a 20% penalty. On the flip side, if you use HSA funds for nonmedical expenses after age 65, you pay only ordinary income tax (similar to a traditional IRA).

As always, it’s important to speak with your financial advisor or tax professional since there are specific rules for eligibility and disbursement of funds from this type of account.

Linde Carroll is an Investment Consultant at Vancouver-based investment management and financial planning firm Sustainable Wealth Management. She can be reached at linde@sustainablewealthmgt.com.

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