Health Savings Account 101
A health savings account, or “HSA” (not to be confused with a Flexible Spending Account “FSA” or the Health Reimbursement Arrangement “HRA”), is a medical saving account that lets you save pre-tax money to spend tax-free on medical expenses.
The best advantage of an HSA is the triple tax benefit.
Contributions to an HSA are pre-tax or tax-deductible. Similar to a 401(k) or Traditional IRA.
Earnings grow tax-deferred.
Qualified medical expenses are tax-free. Similar to a Roth IRA.
In other words, it combines the tax benefits of the Traditional IRA and the Roth to create one of the most tax-efficient accounts available. So if it's so great, what else do you need to know? Read below to find out everything you need to know to make the best-informed decision.
How do I establish a Health Savings Account?
To open an HSA, you need to enroll in a High-Deductible Health Plan (HDHP). In exchange for lower premiums, you’ll have a higher deductible. Meaning, if you have significant unforeseen medical expenses, you may have hefty out-of-pocket expenses. Additionally, once you enroll in Medicare at age 65, you can no longer make contributions, but you do get to keep your account.
If you get your health insurance through your employer and you are on their HDHP, they likely already have a relationship with an HSA provider. Talk to your HR department to get more information.
If you are self-employed or purchase your health insurance outside of your employer, then you get to choose where to open your HSA. At Financial Optimist, we have reviewed dozens of providers and are proud to give the gold medal to Fidelity. If you want to look at other options, we also recommend Lively or HSA Bank. As always, pay attention to those fees and which providers offer an HSA with a regular savings account (we don't want), and which providers also let you add an investment account to your HSA (what we want).
Why the Fidelity HSA?
No fees. Truly, no fees at all. Especially if paired with the Fidelity ZERO Total Market Index Fund (FZROX). This index fund has no management fees, 0.00%.
Quality trusted provider that makes opening the HSA and maintenance of the account an easy feat.
Did I mention no pesky fees?
Is a High-Deductible Health Plan a good option for me?
If none of the members of your family suffer from an expensive, chronic medical condition, an HDHP with an HSA could be a great option for you. If you want to lower your taxes by saving pre-tax money, but your income is too high to use a traditional IRA, an HSA could be a great option for you! If you are part of the FIRE community and want to optimize your finances, an HSA could be an excellent option for you and the family. In short, the HSA is particularly useful for high-income professionals.
However, if you expect a significant medical expense (such as pregnancy or planned surgery), an HDHP with an HSA may not be the best option...for that year. One should consider many details, but feel free to reach out with your specific situation! I’d love to learn about you and your family and offer you unbiased guidance.
How do I fund my HSA and get the tax break?
In 2021, an individual covered only by an HDHP may contribute $3,600 to an HSA (see chart below for a full breakdown). A family (defined as two members, not necessarily both spouses) may contribute $7,100 in 2021. If one family member is 55 or older, there is an additional $1,000 “catch-up” contribution permitted. Note that contributions for 2021 can still be made until April 15th, 2022.
If you open your HSA with your employer, it is best to contribute to your HSA through payroll deductions. In the eyes of the IRS, any money you put into your HSA reduces the amount of your taxable income, so you’ll pay less tax! As an additional benefit, you also do not pay FICA taxes (Social Security and Medicare taxes) on money saved to your HSA through payroll contributions.
If you are not going through your employer, and you decide to open the Fidelity HSA, write a check or make an online transfer into the account. You’ll get your tax benefit by listing the contributed amount as an adjustment to your gross income on the front page of your tax return, thus reducing your income. Unfortunately, in this situation, you do not get the benefit of lower FICA taxes.
How do I use my HSA to pay for medical expenses?
Many HSA's will issue you a debit card that you can use to pay medical expenses directly from your account. Since you put pre-tax money into the account, you are now using pre-tax money to pay for your medical expenses. However, the best way to use the HSA is not to use it all. Wait, what? I know what you are thinking, but here is the deal.
While HSA dollars must be spent on health care to be withdrawn tax-free, there is no requirement under current law that the withdrawals be taken in the same year the health care is purchased. At FP For Good, we recommend that you save all receipts to allow for future tax-free withdrawals from the HSA. All you need to do is simply snap a picture of your itemized medical receipt and save a report of all those medical expenses throughout the years. One strategy to consider is adding all receipts into WaveApps (a free accounting software that can easily run reports and keep track of all the medical expenses).
Remember that with an HDHP, you will be paying more for doctor visits and prescriptions than you would under traditional health insurance. This is because of the higher deductibles. You are also generally paying lower monthly premiums because of this. And with HDHP's, your preventative visits (like your annual physical) are fully covered with no deductible required.
In order to not owe taxes (and a 20% penalty) on the money coming out of your HSA, you have to use it for “qualified medical expenses.” These are explained in detail in IRS Publication 502, “What Medical Expenses Are Includible?” but generally, the HSA can pay for doctor visits, prescription medications, hospital stays, etc.
What if I don’t use all of the money I put into my HSA this year?
That’s okay! Remember, this is not to be confused with an FSA or HRA's. Unlike some other types of medical savings account, you do not lose any money that remains in your HSA. You can keep it there for future year’s expenses. You even get to keep the account if you leave your employer. And if you still have money in your account after age 65, you can treat the account as a traditional IRA and pay income taxes on the amount you take out for non-medical reasons.
Many people think about these accounts as merely a way to pay for current medical expenses. However, suppose you can afford to pay for current medical bills out of pocket or develop a game plan to do so. In that case, you might find that HSA contributions are one of the most beneficial ways to accumulate retirement savings or even an emergency fund. Remember, as long as you save all medical receipts throughout the years, you can reimburse yourself in the future at any time that you require the funds.
Parting Words?
Health Savings Accounts are the best investment account available to an investor and perhaps the first place to invest each year. HSAs have superior tax protection features compared to any other investment account including their triple tax-free advantage, the ability to withdraw the money after 65 for any purpose penalty-free, and the ability to delay withdrawals while saving the medical receipts.
