If you like
traditional and Roth IRAs, then you might love the long-term growth potential
of health savings accounts. They provide very similar benefits.
by: Kevin Peacock, CFP®, CAIA® May 3, 2017
At
face value, being subject to a high-deductible insurance plan may seem
frustrating, but having one also gives you access to an HSA, which is a
compelling benefit.
Typically,
health savings accounts (HSAs) are used as savings accounts for medical
expenses, providing tax-deductible contributions and tax-free withdrawals.
There is, however, an interesting fringe benefit: Some providers allow you to
invest your HSA in mutual funds and ETFs, allowing the balance to grow
tax-free. If your company provides an HSA that does not offer these investment
options, you are free to utilize any HSA plan, as long as you meet HSA eligibility requirements:
·
You must be covered
under a high-deductible health plan.
·
You can’t be enrolled
in Medicare.
·
You can’t be claimed
as a dependent on some else’s tax return.
HSAs have properties like traditional and Roth
IRAs
HSAs
have the potential to provide the benefits of both a traditional IRA and a Roth
IRA. Because contributions to an HSA are made on a pretax basis — like a
traditional IRA — they decrease taxable income by the amount contributed. In
addition — like a Roth IRA — you could potentially have tax-free growth and
tax-free distributions equal to qualified medical expenses. Keep in mind that
while HSA dollars cannot be utilized for insurance premiums or over-the-counter
medication, they do cover most other out-of-pocket medical expenses, including
dental work and eyeglasses.
Withdrawals
from HSAs are flexible, too. There is no requirement to take distributions once
you incur medical expenses. You may make these qualifying withdrawals after
setting up the account at any time, whether that's next week or 30 years from
now.
For
example, say that at the beginning of 2017 you open an HSA for your family and
contribute the maximum of $6,750. During 2017, you have $1,000 in out-of-pocket
medical expenses. Instead of withdrawing the $1,000 from your HSA, you can opt
to leave the $1,000 in the account to grow and compound.
As
long as you keep your medical receipts, physically or digitally, you can
withdraw qualified expenses at any time, tax-free. Your family would have saved
the tax on the $6,750 of deductible contributions used to fund the HSA, and
$1,000 is eligible for tax-free withdrawal, today or decades from now. Future
qualified medical expenses add to the amount that you can withdraw tax-free at
any time.
What
if the account grows to a value that exceeds future medical expenses? Once a
person turns 65, they can tap into their HSA the same way they could a
traditional IRA: They could make penalty-free withdrawals to pay for anything,
not just medical expenses. After age 65, you would pay income tax on
distributions that aren’t used for qualified medical expenses, similar to a
traditional IRA, but there would be no additional penalties or fees.
Deductible and contribution limits
HSAs
are available to taxpayers with high-deductible health plans (HDHP). The
minimum deductible must be at least $1,300 for an individual or $2,600 for a
family to be considered an HDHP. In order to qualify as an HDHP, a health
insurance plan must not offer any benefit besides preventive care before
meeting the annual deductible. This means that the deductible must apply to
prescriptions, visits with specialists and emergency room care, or it is not
considered an HDHP. Additionally, the total yearly out-of-pocket expenses
(including deductibles, copayments and coinsurance) can’t exceed $6,550 for an
individual or $13,100 for a family.
In 2017, the maximum annual HSA contribution for a family is
$6,750 and $3,400 for an individual. There is also a catch-up contribution of
$1,000 for each family member over the age of 55. Unlike flexible spending
accounts (FSAs), there is no limit on when funds in an HSA must be used.
There
are some important caveats to consider, however. While surviving spouses may
inherit the HSA as if it were their own, the entire account will become taxable
income to any non-spouse who inherits it. Unclaimed reimbursed expenses will
also be lost. Additionally, Alabama, California and New Jersey do not recognize
HSAs, which means that contributions are not deductible and earnings are
taxable for state tax purposes in those states.
Does a High-Deductible Health Plan make sense
for you?
It
is important to carefully analyze whether it makes sense for your family to
make the switch to a high-deductible health plan instead of a traditional plan,
which typically has a lower deductible but higher premiums. If you have few
annual medical expenses or very high medical expenses, an HDHP could make a lot
of sense. Here’s why:
·
If you rarely need
medical care, then you can save on premiums by getting a high-deductible plan
and pumping the savings into your HSA. A few years down the road, you’d have a
nice, tax-advantaged nest egg built up for future medical expenses.
·
If you routinely have
high medical expenses that exceed the deductible of an HDHP, you may end up
with total out-of-pocket expenses similar to those with traditional health
plans, when you take into account the price difference in premiums. However,
with a high-deductible plan, you’d gain an important bonus: access to an HSA.
Every plan is different, so if your health spending tends to be very high, be
sure to calculate your total health expenditures, accounting for both premiums
and likely out-of-pocket costs, before making this important decision.
·
If you typically have
expenses that hover near the deductible of a high-deductible health plan, you
may be better off utilizing a more traditional health insurance plan, as your
total costs with the HDHP may be higher. In this scenario, it is also important
to project your total expenses for both the traditional option and HDHP option,
based on your anticipated medical spending.
The
bottom line is that HSAs significantly increase the appeal of high-deductible
health plans. By thinking of your HSA as an additional retirement account, you
can reduce your tax burden now, benefit from tax-free growth in the future and
make tax-free withdrawals at any time, up to the amount of past medical expenses.
This
article was written by and presents the views of our contributing adviser, not
the Kiplinger editorial staff. You can check adviser records with the SEC or
with FINRA.
Kevin Peacock, CFP®, CAIA® Managing Member, Astra Capital Management Kevin Peacock is the managing member of Astra
Capital Management, a fee-only investment advisory firm based in New
York City. Astra Capital Management utilizes an evidenced-based approach to
investment management and financial planning customized for each client's
unique wealth objectives. Kevin is a CFP® professional and holds the CAIA®
designation. His educational background includes a master's degree in Financial
Engineering and an MBA with a finance concentration.
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