Hidden Benefits of Health Savings Accounts

• Health Savings Accounts (HSAs) are an increasingly popular employee benefit that, when used the right way, can help you build long-term wealth through their unique tax advantages and flexibility
• Funded with pre-tax dollars with qualifying withdrawals being tax-free, there are added benefits that you might not be aware of
• HSAs have important rules, but the account is available to anyone if certain criteria are met

Making the most of your employee benefits goes a long way toward building long-term wealth. A Health Savings Account (HSA) paired with a High Deductible Health Plan (HDHP) is often a great tool to not only set money aside to cover health-related expenses, but also an effective long-term wealth-building account. 

Consider that money in an HSA has the ‘triple-tax advantage’ of using pre-tax dollars to fund the account, earnings grow tax-free, and qualifying withdrawals are also tax-free. What’s more, you can tap the account similar to a Traditional IRA once you turn 65 – taking distributions for any purpose without incurring a penalty. Lastly, you can simply store receipts from qualifying health expenses in safekeeping, leave your HSA untapped, and let the account grow for as long as possible, paying yourself back much later on.

But did you know there are other significant, hidden benefits to having an HSA? Let’s explore those. You might discover that an HSA is among the most valuable savings vehicles.

1. Flexibility

HSAs are one of the best savings accounts out there since the money is always yours – there is no ‘use it or lose it’ feature like with, say, Flexible Spending Accounts (FSAs). Moreover, you can tweak your HSA contribution level throughout the year and any unused money simply rolls over to the following year without you having to lift a finger. What’s also nice about HSA contributions is that they go through your employer’s payroll, so much of the leg work is done with little effort. Finally, you get an extra savings boost since HSA contributions bypass FICA and FUTA taxes – an extra 7.65% kicker!

2. Catch-up contributions

HSAs are kind of a new thing. They were established in 2003, but the account type didn’t garner popularity until years later. Adoption in the employee benefits space is often slow, but HSAs are now a common feature of many employer health plans. So, if your HSA balance is not that high and you are nearing retirement, you are not alone. And there’s good news: You can make so-called catch-up contributions like you would with IRAs and your 401(k). Once you hit age 55, you can put in an additional $1,000 per year into your HSA. That is on top of the 2023 limits of $3,850 for self-only HSAs and $7,750 for family plans. 

3. Opportunity for adult children

Are you looking for ways to help your kids financially? One of the most effective ways to do so is to help them fund their own HSA. Many people know that children, until age 26, can be covered by a parent’s health insurance policy, but what many families overlook is the fact that those adult sons and daughters can open and fund their own HSAs, even if they are married or not living with their parents. Now, they’d have to open an account at a brokerage site and fund the HSA like they would an IRA, but for a young couple, socking away up to $7,750 annually can be a great head start on saving for inevitable health expenses or simply a way to build early retirement savings.

4. Savings account proxy

I’ve hinted at this strategy already, but let’s draw out how it works. You can leverage your HSA dollars for your retirement and long-term savings by simply maxing out your HSA yearly, saving your medical and health expense receipts, then ‘reimbursing’ yourself years, perhaps decades, down the line. Since HSA dollars can be withdrawn at any time to cover qualifying medical spending, it’s allowable to put off taking money out indefinitely. That way, if you have a major non-medical cash outlay – maybe paying for a child or grandchild’s college tuition, buying a second home, or funding retirement travel – an HSA can be your go-to account for tax-free withdrawals. The account can even be used as a rainy day or emergency fund. All you must do is keep good records of your receipts.

5. Caring for a loved one

HSA money covers qualifying healthcare costs for yourself, but also any dependents on your tax return. For instance, if you have an aging parent for whom you care, the IRS allows you to claim them as a qualifying dependent so long as they meet certain criteria. The same goes for children and other relatives. So, if you pay for their qualifying expenses, you can take tax-free HSA distributions. 

There are a few other features and rules to know about with HSAs. 

• Qualifying expenses. The list of HSA-eligible medical expenses is seemingly endless, but you should always review what counts and what doesn’t. Common costs include copays for prescriptions and office visits, dental and vision care, X-rays, annual exams, childbirth, ambulance services, hospital stays, and urgent care services. Insurance premiums, including those for long-term care, do not count, though.
• No earnings test. While high-income individuals are disqualified from funding a Roth IRA or making tax-deductible contributions to a Traditional IRA, you can put money into an HSA no matter your income.
• No Required Minimum Distributions (RMDs). The IRS mandates that you begin taking annual RMDs from certain tax-advantaged retirement accounts, but that does not go for HSAs. 
• Employer matching contributions. Be sure to check with your employer to see if they have a matching feature like they might with a 401(k) plan. Many firms offering an HDHP and HSA will make a partial contribution on your behalf – either a fixed amount or a percentage of your contribution level. Your total yearly HSA contribution must still fall within the overall annual limit, though.
• You cannot be enrolled in Medicare. Many individuals turning 65 will be ineligible to fund an HSA as soon as they are on Medicare. The good news is that you can still take tax-free distributions for qualifying expenses. That’s also the age when you can take withdrawals for non-qualified expenses without incurring a penalty – but the distributions would be subject to income tax.
• Significant penalty for non-qualifying distributions. It’s not all sunshine for HSAs. If you pull money from the account for non-qualifying purposes, the IRS imposes a nasty 20% penalty. So, if you need cash, there could be better options at your disposal. That is when working with a financial planner can help you avoid fees, penalties, and taxes as much as possible.

The Bottom Line

HSAs are becoming more popular as people discover all the benefits of funding the accounts and letting them grow. With big tax benefits and flexibility, it’s sometimes wise to prioritize HSA contributions over other saving and investing accounts. 

Looking to be proactive with protecting your money? Here are three strategies you can use to fight inflation right now.