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HSA: Now and Later

HSA: Now and Later

| March 26, 2021

I just got off the phone with a couple in their late 30's and early 40's; After discussing several financial planning decisions and updates we talked about the weather in Colorado where they are vs. Florida where I am. Naturally, I bragged about my week at the beach and they bragged about the time on the slopes. To each his own. As we wrapped up the call, they had one more question. Life is good for them as their careers in corporate America rebound  in a post-Covid environment. In fact, they had access to Health Savings Accounts or HSAs. The question was: "should we throw a few dollars at the HSA or a few more dollars at the 401k?"

It's a great question and their situation may not be yours so let me give you some broad insights and possible strategies. 

HSAs in the Now

First the basics. If you have a qualifying high-deductible health plans you may be eligible for an HSA. Hopefully, your company provides one, but if not you may be able to set one up individually.

What's amazing about HSAs is the triple tax benefit. Contributions to your account are tax-deductible now, grow tax free and are not taxed if spent on eligible medical expenses in the future. There's a lot of eligible expenses like deductibles and co-pays. Keep in mind that your medical health premiums are not eligible. More on that in the next section.

Each year, you decide how much to contribute to your HSA account, but there are limits. It's best to set up easy automatic contributions directly from payroll. Your HSA balance rolls over from year to year, so it's not a "Use it or Lose It" proposition.

It's important to understand that right now the tax benefits of the HSA are powerful. Contributions are deducted from earned income. The next day you can withdraw it and spend it on an eligible medical expense. The reason that this is that you may deduct only the amount of your total;medical expenses that exceed 7.5% of your adjusted gross income. That's a lot for most of us. And are you nerdy enough to track and keep receipts especially if it's been a medically stressful year. With the HSA you don't have to worry about the 7.5% rule or a shoebox of receipts. 

HSAs for Later

Once you're over age 65 and enrolled in Medicare, you can no longer contribute to an HSA, but you can still use the money for out-of-pocket medical expenses. If you use the money on non-eligible expenses, you have to pay income tax on that amount (plus a penalty if you're under 65). You'll recall that you can't pay for medical insurance premiums with your HSA. But at 65 something magical happens. Wait for it…

The government will let you pay for health insurance premiums as long as you are paying them! That's right! You can use your HSA funds, free of tax and penalty, for to pay for Medicare Parts A, B, D premiums and Medicare HMO premiums. Keep in mind, thought,  premiums for a Medicare supplemental policy, such as Medigap, are not eligible expenses.

So I explained all this to my couple client in Colorado and they were thrilled at the idea of doing something long term. They will max out their HSA which is appropriate in their situation. They will allow the money to grow with a target of having a lot of money in their HSA untouched at 65. Then they’ll use the HSA as a retirement healthcare account. If there's a medical emergency or finances get tight before 65, they can dip into their HSA as most normal people would. But if they can cashflow their healthcare now, while contributing to their HSA, the potential for their HSA in retirement is quite bright from a tax and income planning frame of reference.

I realize this is a lot to digest, so think of your HSA as a Traditional IRA when you contribute and a Roth IRA when you distribute on eligible expenses. It's the best of all worlds.

If you'd like more information or want to apply this to your situation, click here.