How HSAs Can Make You Healthier And Wealthier

You’ve probably heard of IRAs and maybe FSAs, but what about HSAs? If your employer offers high-deductible health insurance policies, or if you’ve tried shopping around for low-cost health insurance, you may have run across this acronym. As their popularity has grown, so have the questions about them.

So what exactly is an HSA? It stands for Health Savings Account and is a way to save for health expenses tax-free. In order to be eligible to contribute to an HSA, you have to have a health insurance policy with a deductible of at least $1,400 for single coverage or $2,800 for family coverage in 2021. That deductible is generally how much you have to cover out of pocket before the insurance even kicks in.

The main advantage of these high-deductible policies is that the premiums are a lot lower than for policies that pay benefits sooner, and the premiums don’t tend to rise as much. One of the reasons their premiums haven’t risen as much as others has to do with the effect they have on the policyholders. Normally, you might just go to the doctor and not think about costs since someone else (the insurance company directly and your employer indirectly through higher premiums) is paying. Think about how you’d spend money differently if other areas of your life worked that way. (As someone who loves to eat out, I wish my company provided us “food insurance”).

I’ve personally had a high-deductible policy since I graduated from college, and I can tell you that it certainly makes you think more like a consumer. When the dentist asks when was the last time I had my x-rays done, I make sure I know the answer before paying for x-rays I don’t need. I only update my contact lens prescriptions when they expire or need updating, not every time I happen to be in the optometrist’s office for a routine checkup since it costs extra for the prescription. I probably wouldn’t do any of these things if the insurance was paying for everything. Because other policyholders are doing the same thing, it helps keep the overall costs and premiums down.

With a high-deductible policy, you and/or your employer have can make HSA contributions up to a total of $3,600 per year for an individual or $7,200 for family coverage in 2021. If you’re 55 or older, you can contribute an additional $1,000. You also have until the tax filing deadline (typically April 15^th) to contribute for the previous year.

Like a pre-tax 401(k), these contributions aren’t taxable, whether made by the employer or the employee. If you have them deducted from your paycheck as part of a cafeteria plan, you won’t have to pay payroll taxes on them either. (Not even your 401(k) lets you do that.) Like a Roth IRA or 401(k), they’re not taxable when they come out as long as the money is used for qualified health care expenses. This means they have the potential of the best of both worlds: pre-tax contributions and tax-free withdrawals.

However, if you withdraw the money for non-qualified expenses, you’ll have to pay a tax on the withdrawal plus a 20% penalty if you’re under age 65. What if you fulfill your New Year’s resolutions, live a healthy lifestyle, and don’t need all the money for health care expenses? Unlike an FSA (flexible spending account), the good news is that your unused HSA money can be rolled over to the following year. If you don’t use it, you don’t lose it.

Once you turn 65, you can then withdraw that HSA money penalty free for any purpose. (It’s also still tax free if used for qualified medical expenses). It essentially becomes a tax-deferred retirement account at that point like a traditional 401(k) or IRA. In fact, many people use it explicitly for this purpose and don’t take withdrawals even when they have qualified health care expenses prior to retirement.

Many HSA custodians will even allow you to invest your HSA money in mutual funds for the long term. However, you probably don’t want to invest any money you might need within the next 5 years. Otherwise, the money may not be there when you need it or you could be forced to withdraw it at a loss if the investments drop in value.

There’s also a quirk in how HSA withdrawals are treated that makes using an HSA as a long term account even more appealing. That is you don’t have to withdraw money from the HSA in the same year that you have a health expense for it to be tax free. For example, you can have a $1k health expense this year and withdraw that $1k tax free 20 years from now. In the meantime, you would have accumulated 20 years worth of interest and/or growth on that $1k tax deferred and potentially tax free if used for qualified healthcare expenses in the future. So keep those receipts for unreimbursed expenses in a safe place.

There’s a good chance you’ll have enough future health care costs for all that growth to be tax free. A recent Fidelity study concluded that a typical 65-year-old couple retiring without retiree health insurance would need $295k throughout their lifetime to pay for all the projected health costs that Medicare doesn’t cover. This doesn’t even include over-the-counter medications, most dental services, and long term care. Nor does it factor in any Medicare cuts that may be needed to keep the program solvent.

HSAs don’t just benefit your wallet though. Knowing that you’re financially liable for your health care costs can encourage healthy living. The HSA can also be used for some wellness programs and alternative medicine practices that traditional insurance policies don’t always cover.

Of course, not everyone benefits from high-deductible policies. If you don’t have enough savings to fund an HSA, you might have trouble meeting your deductible. Any chronic conditions could also make it difficult to accumulate savings in the HSA so if you want to get the full benefit, that’s one more reason to get started on those New Year’s financial and health resolutions.