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.
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