This guest post is from Cato Johnson. Cato is a millennial, an attorney, and the co-founder of The Dollar Build, a personal finance site aimed at educating millennials, young adults and professionals about ways to take charge of their finances and live a rich, fulfilling life.
With the seemingly never-ending debate over the Affordable Care Act, you’re probably tired of hearing about healthcare. If that’s the case, just the thought of spending a few minutes considering the type of health care plan that’s right for you probably seems like torture. And it doesn’t get any better when you start throwing around all those acronyms – HMO, PPO, FSA, HSA, etc.
It’s easy to feel overwhelmed.
That’s why I want to take a few minutes to explain the benefits of a Health Savings Account, or an HSA.
HSAs go hand-in-hand with high-deductible health insurance plans (HDHPs). In general, HDHPs pair high deductibles with lower monthly premiums. Admittedly, HSAs aren’t ideal for everyone. But if you’re interested in limiting your upfront health care costs while saving for future medical or retirement expenses, then an HSA might be right for you. If that’s the case, you’ll want to know about the favorable tax treatment and other perks that come with an HSA.
With than in mind, here are ten reasons to contribute to an health savings account:
Pre-Tax Contributions that Reduce Your Taxable Income
The most well-known benefit of an HSA is the tax savings. The money you contribute is pre-tax and every dollar you contribute reduces your tax liability. That means you can reduce your tax liability even though you’re keeping your money and building up your medical savings. This is a huge advantage of the HSA and this fact alone makes contributing to and HSA attractive. The maximum allowed contribution for 2014 is $3,300 for an individual and $6,550 for a family. This is net of your personal contributions and your employer contributions.
No Taxes on Qualified Medical Expenses
Not only can money go into your health savings account tax-free, but it can come out tax-free too when you use it for qualified medical expenses. Don’t underestimate the potential savings you can gain from this tax benefit. For a middle-class wage-earner, every $100 in income is reduced by roughly $40 after federal, state, and FICA taxes are accounted for. Using your health savings account funds to pay for qualified medical expenses means you can keep more of your hard-earned extra money! Why would anyone pay for qualified medical expenses with after-tax dollars?
In case you’re wondering which medical costs qualify for this treatment, check this detailed list of qualified medical expenses from the IRS.
Note: If you use your HSA funds for non-qualified medical expenses before you turn 65, that withdrawal is subject to regular income tax plus an additional 20% penalty for the early HSA distribution. After age 65, you can use the money in an health savings account for any non-health care expenses without penalty, but it will be taxed as income.
Most HSAs will issue a debit card that you can use to pay for qualified medical expenses such as deductibles, co-pay, or prescription medication. Alternatively, you can wait for the bill to arrive in the mail. At that time, you can make a payment over the phone using your debit card or use the card to access cash at an ATM.
Some employers will match your HSA contributions dollar-for-dollar up to a certain amount. My employer matches the first $300 that I contribute. That’s an extra $300 in free money every year for just building my medical savings. If your employer matches contributions make sure you’re taking advantage of that “free” money.
Note: Remember, both your contributions and your employer’s count toward your annual HSA limit. HSA contribution limits for individuals are capped at $3,400 for 2017. Let’s say your employer contributes $1,000. That means your contributions would be capped at $2,400 this year.
Various Contribution Sources
Your employer might not match your HSA contributions, but that doesn’t mean you have to be the sole source of funds. HSA Contributions can come from a variety of sources. In fact, they can come from anywhere – a spouse, friend, relative, or anyone else who wants to add to your HSA.
Establish a Medical Emergency Fund
One of the downsides of an HSA is that you must be enrolled in a high-deductible health insurance plan to be eligible. While lower monthly health insurance premiums will almost certainly save you some money, that high-deductible can leave you with sizeable medical bills if an unexpected medical emergency arises. Most people have an emergency fund to cover unexpected life events (e.g., job loss, auto accident, etc.). Why not create a medical emergency fund that can help you ease the financial implications of an unexpected medical situation while also taking advantage of the tax benefits that come with an HSA?
Earnings Accumulate Tax-Deferred
Did you know that most HSAs allow you to invest your contributions?And did you know that any interest or earnings on the assets in your HSA are tax-deferred?!
It seems that many consumers aren’t aware of this benefit. As of 2017, there are approximately 18.2 million HSA accounts. The average account is valued at over $15,000 but just 15% of that amount is invested. That means most people are missing out on a great opportunity to grow their medical savings (or retirement savings). That especially unfortunate when you consider that HSA funds that aren’t invested typically experience a minuscule amount of growth, if any.
While it may seem odd to mix health care contributions with investing, HSA investments aren’t that complicated. In fact, they are quite similar to a 401(k) or IRA. The bottom line is that an HSA is an excellent way to grow your medical savings with tax-deductible contributions. Make sure you’re taking advantage by funding your HSA account with as much as you can afford for as long as possible!
Rollover Contributions Year After Year
Sometimes people associate HSAs with Flexible Spending Accounts (FSA). While both accounts have excellent tax benefits, there is one major difference: the money you contribute to your HSA is yours to keep.
FSAs are accounts that contain a certain amount of money (employee and/or employer contributions) that can be used on qualified medical expenses throughout the year. In many cases, if you don’t use the money by the end of the year, it’s gone. Unlike an FSA, your HSAcontributions rollover year after year. This is an important distinction, because it means you control how the money is spent and won’t feel the need to burn through contributions
Keep Your Contribution When You Switch Jobs or Health Plans
Like I said above, your HSA contributions belong to you. You can use the funds in your HSA for future qualified medical expenses even if you change health insurance plans, find new employment, or retire.
Secondary Retirement Account
Earlier, I mentioned that you are able to contribute pre-tax dollars to your HSA and even invest those funds in the market. What I didn’t mention was that you can basically treat your HSA like a retirement account. You can use your HSA funds to pay for qualified medical expenses at any time, but there’s a possibility that you’ll still have funds in your account when you turn 65. At that time, withdrawals from your HSA will be treated similar to withdrawals from a Traditional 401(k) or IRA – they are treated like regular taxable income.
A Few Final Thoughts
As you can see, there are many reasons to contribute to an HSA. They are one of the most tax-advantaged accounts available. Being able to spend income for qualified medical expenses without ever being taxed is probably at the top of the list of benefits. But there are so many other benefits to having an HSA.
In fact, as an investment vehicle HSAs have so many advantages over traditional IRAs that you might consider funding your HSA before you contribute to your IRA. In any event, it makes a lot of sense to make regular contributions to an HSA. You’ll be prepared financially in the event of a medical emergency. And in a “worst case scenario,”you’ll have a second retirement fund that you can draw from down the road!