Build Your Private Healthcare Fund with a Health Savings Account (HSA)
Did you know there is a triple tax-free way to save for medical expenses? Perhaps the media hoopla over the Affordable Care Act (aka Obamacare) these past five years has overshadowed the potential of Health Savings Accounts (or HSAs). Individuals or families who are covered by high-deductible health plans are eligible to contribute to HSA accounts with pre-tax dollars. These accounts may invest in stocks and bonds, grow tax-deferred, and qualified distributions are tax and penalty free.
HSAs were created by the 2003 legislation, the Medicare Prescription Drug, Improvement, and Modernization Act signed by President George W. Bush. To qualify for an HSA, an individual must be covered by a high-deductible health plan (described later), have no other health coverage, not be enrolled in Medicare (so under age 65), and not be claimed as a dependent on another’s tax return. In 2015, the minimum annual deductible is $1,300 for single coverage and $2,600 for family coverage. This means you must pay the first $1,300 / $2,600 of your medical expenses out-of-pocket, something many Americans are unaccustomed to doing. Individuals may contribute up to $3,350 to an HSA in 2015, and families may contribute up to $6,650. There is an additional $1,000 catch up contribution for individuals over age 55.
Unlike its predecessor the Medical Savings Account (MSA) an HSA account may accumulate funds, with no requirement to spend contributions in the same year. Better yet, individuals may invest HSA account funds in stocks and bonds, and the earnings inside the HSA are tax-deferred. Withdrawals for qualified medical expenses are tax and penalty free, while nonqualified withdrawals are subject to income tax and a 20% penalty before age 65. The HSA is essentially a personal IRA (individual retirement arrangement) for medical expenses both today and in retirement.
Here’s where things start to get interesting. If an individual or family can pay additional medical expenses out-of-pocket, without dipping into their HSA funds, the HSA can really grow. A couple, age 40, that maxes out an HSA every year until age 65 and earns a 5% return on their investments, can accumulate more than $400,000 in an HSA. Medicare Part B & D premiums and some long-term care insurance premiums are qualified medical expenses that can be paid from an HSA. Medicare premiums run as high as $400 per month, $9,700 a year for a high income earning couple. With an HSA, you can cover these expenses without using Social Security payments or withdrawals from your other retirement savings accounts.
* Assumes annual rate of return on investments of 5% each year. Future investment returns are unknown and unpredictable. Assumes max contribution rates annually with 2% cost-of-living adjustment each year. Future increases to maximum contributions rates are determined by legislation and are unknown.
Despite the potential benefits, HSAs may not be the right strategy for everyone. Individuals with known, high and recurring, out-of-pocket medical expenses may be better off paying higher health care premiums for a low deductible plan. Young families, with multiple children, may also wish to avoid paying high out-of-pocket expenses. Individuals looking to adopt an HSA strategy need a savings account dedicated to covering the high annual deductible, if necessary. Otherwise, unexpected out-of-pocket medical expenses could be a budget buster. HSA savers should also be sure to spend as much as possible from the account on qualified medical expenses during their lifetime. Spouses may inherit an HSA and continue to use it for qualified medical expenses, but non-spouse beneficiaries must withdraw all funds within the first year and pay income taxes on the full amount.
An HSA is a powerful, potential tax savings strategy. With a bit of careful planning, it can be a nifty way to offset healthcare costs during retirement.
Information presented does not involve the rendering of personalized investment advice and should not be construed as an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Tax information is general in nature and should not be viewed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
