Over the years, health savings accounts (HSAs) have become increasingly popular. According to the Bureau of Labor Statistics (BLS), access to HSAs increased from 14% in 2010 to 30% in 2019 for private industry workers. Moreover, in 2019, 47% of workers in the largest organizations (consisting of more than 500 workers) had access to HSAs.
At the same time, research has shown that Americans are spending far more than they are saving in their HSAs. And this spending does not necessarily involve major medical expenses like surgery; the average user is spending half of it on just regular doctor’s visits. As a result of these spending habits, HSA users are losing out on potential long-term tax and savings benefits.
To ensure that you can maximize the potential of your HSA, you should be aware of its key benefits.
An HSA can offset the costs of high-deductible health plans
HSAs are available to you when you’re enrolled in a high-deductible health plan (HDHP), which the IRS defines as having a deductible of at least $1,400 for an individual and $2,800 for a family in 2021. HSAs have increased in popularity to help plan for and cover the high deductibles associated with HDHPs.
HSAs offer flexibility
Unlike your health insurance and flexible spending account (FSA), which are typically linked to your job, you own your HSA. This means if you get laid off, furloughed, or you choose to leave your job, your HSA funds stay with you and you can always use your savings to help pay for medical costs. Also, with an HSA, you can change your contribution amount at any time during the year. You’re not locked in to the amount you chose during your open enrollment period.
New legislation makes it easier to use your HSA dollars
In March 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act to help Americans affected by the pandemic. Part of this legislation enables HSAs to be used to purchase some over-the-counter medical products and medicines without a prescription.
HSAs offer a “triple tax” advantage
One major benefit of an HSA is the triple tax advantage:
- Contributions made to your HSA are pre tax and reduce your taxable income
- Your HSA funds grow tax-free
- When used to pay for eligible medical expenses, HSA withdrawals are tax-free
The IRS states that, for 2021, HSA contribution limits are $3,600 for individuals and $7,200 for family coverage. If it’s affordable, we recommend maximizing your HSA contributions so you can enjoy the full advantage of the triple tax benefits.
Your HSA is a retirement benefit
HSA users can contribute money in their accounts to plan for future health costs while also investing in mutual funds (e.g. target-date funds, active and passive equity, bonds, fixed income) once the account reaches the investment threshold. This feature is especially useful when you consider how the US is facing a retirement crisis, driven – in part – by the ever-increasing costs of healthcare.
Also, HSAs don’t have required minimum distributions, which is appealing from a retirement perspective. You can keep money in your HSA during your working years and invest it so it grows in value. Then, you can take tax-free distributions to pay retirement medical expenses, when those expenses are likely to be higher.
If your spouse is your beneficiary, they can enjoy all the benefits too
When you pass away, your HSA balance goes to the beneficiary you named. If your beneficiary is your spouse, the account will remain an HSA and your spouse will be its new owner. Distributions to pay or reimburse medical expenses will continue to be tax-free while distributions for non-medical expenses will be taxed the same as they would if you were the owner.
There are no rules about withdrawing at a certain age
Unlike a 401(k) or IRA, an HSA does not require the user to begin withdrawing funds at a certain age. You can leave your account untouched for as long as you like. However, you will no longer be able to contribute once you enroll in Medicare (which you become eligible for at 65).
You can carry your balance over from year to year
Another benefit of an HSA is that you can carry your balance over from year to year. You are under no legal obligation to ‘use it or lose it’ as you are with an FSA.
Senior citizens can withdraw HSA money penalty-free for any purpose
Once you turn 65, you can withdraw money from your HSA for non-medical purposes without paying a penalty. You only owe taxes on the withdrawal at your usual income tax rate.
HSAs can be enjoyed by all types of earners
While some high-earners cannot contribute to Roth IRAs or make tax-deductible contributions to traditional IRAs, you can qualify for an HSA regardless of how much you earn.
HSAs are not without their downsides, of course. These include some eligibility restrictions, potential fees, and a 20% penalty imposed on early withdrawals not used for qualified medical expenses. Nonetheless, the benefits of HSAs clearly outweigh the disadvantages for most Americans.