Okay, it is time to talk about the red-headed step child of investment accounts, the HSA (Health Savings Account). For some reason, this is by far the least know, talked about, and used of the major investment accounts. But we are going to change that. So let’s break this down. I am sure you have at least seen this as an option whenever you are reviewing your healthcare options. But let’s answer the big questions: do I even qualify, how does it work, what can I use it for, what happens if I invest too much?
Qualifying for an HSA
The IRS realizes that healthcare can cost a lot. Usually, whenever you are looking at your healthcare options, you can either go for a plan that has a high deductible (you pay a higher amount for your insurance to kick in), but you have lower monthly premiums. On the flip side, you can have much higher monthly premiums, but have a very low deductible, allowing your insurance to kick in much sooner. For the people and families that choose to have a high-deductible plan, the IRS allows you to set money aside in an HAS to help pay for some of those expenses tax free.
For 2017, the IRS defines a high-deductible insurance plan as having an out-of-pocket maximum of $6,550 ($6,650 for 2018) and a minimum of $1,300 ($1,350 for 2018) for an individual. Those with a family plan have a maximum of $13,100 ($13,300 for 2018) and a minimum of $2,600 ($2,700 for 2018). You cannot use an HSA if you do not fall within those parameters. Most health insurance plans will offer you a HSA, but if not you can easily go to another investment institution to set one up.
For 2017, the limitations for an individual are $3,400 ($3,450 for 2018). For families, the limitations are $6,750 ($6,900 for 2018). As with you other investment accounts, there is an additional $1,000 increase for those 55 or older.
How does it Work?
Normally, your plan administrator will either send you a debit card or checks that are linked to this HSA account. If the plan is set up through your work, you can allocate a percentage of each paycheck that goes in to the HSA account, otherwise you can allocate money to your account yourself and then it will become deductible when you file your taxes. You are allowed to use this money for an eligible medical expense. These expenses include copays, deductibles, and coinsurance. Most plans do not allow you to charge premiums, as this would be double-dipping. Here are some of the biggest eligible medical expenses and some of the biggest ineligible expenses, but you should always double check with you plan administrator before spending the money with the expectation that it will qualify:
Advantages to using an HSA
- You can invest your HSA account, preferably into an index fund. This allows your money to grow while you are waiting for an eligible expense to use it for.
- Unlike using a FSA (Flexible Spending Account), your HSA will roll over from year to year. This allows you to keep this account as an accumulating investment account for anything you do not spend.
- There are major tax advantages to using an HSA account:
- Your contributions are pre-tax/tax deductible
- If contribution is through a payroll deduction, not subject to FICA tax (7.65%)
- The money grows free through your investments
- The money comes out tax free for qualified medical expenses
- Your contributions lower your taxable income, lowering your tax liability and possibly lowering your tax bracket
What if I Never Have Enough Qualified Medical Expenses?
One of the best parts of an HSA is that once you turn 65, it can be used like a Traditional IRA. While you can no longer contribute to an HSA once you are 65, you can pull out your money like a Traditional IRA and just pay your normal income tax on it. There is no penalty for not using it on qualified medical expenses at that point. The other nice rule is that there are no required minimum distributions at 70 ½.
Ways That You Can Make Your HSA Work Even Harder For You
Since there are no rules about when you have to submit your qualified medical expenses for reimbursement, some people will collect their receipts and save them. This allows their money in the HSA account to continue to grow tax free. Then, whenever they want/need to get some cash, they can submit all of their qualified medical expenses that they have accrued since opening up their HSA and get that money back tax free. Whenever they turn 65, they can choose to reimburse themselves then for all of their accrued expenses, continue to wait, or just utilize this account like a Traditional IRA.
Things to Keep In Mind
The focus of this article is just to explain what this account is and why it can be a great investment vehicle. However, not all families are in a situation to effectively use an HSA account. If you routinely have a lot of medical expenses, it may make more sense to have a low-deductible health plan rather than a high-deductible. On the other hand, if you only have $200 worth of qualified medical expenses a year, it might make sense to choose a high-deductible, contribute to an HSA, and just pay the $200 out of pocket while letting your money grow tax free. As with most things we discuss here, it is all on a case-by-case basis. Check out the Mad Fientist’s great example here.