Recently, I shared with you all on my Instagram stories that I was at the eye doctor. Anyone else hate eye doctor’s appointments over everything else? Personally, I start feeling sick and could faint when they start talking about my eyes.
The other reason I am not a fan of the eye doctor is that I always leave these appointments with a big fat bill. The result of this most recent visit was a new vision prescription which translated into:
new glasses + new contacts = $$$
For a 30 minute appointment, it was the fastest I’ve ever spent $800.
Normally, getting a bill of this size would give me anxiety but I was prepared thanks to my Health Savings Account (H.S.A).
What is a H.S.A?
A health savings account is part of a high deductible health insurance plan, which may or may not be one of your employer benefits. There are a variety of health insurance plans that I address at a high level in the benefits post but H.S.As are paired with high deductible plans as a way to help cover for the higher insurance deductible.
Account holders have the ability to defer income from their paycheck into a H.S.A. and build a balance over time. You can elect to defer a flat dollar amount each paycheck or a percentage of income but are limited on how much you can contribute to the account. If you have single healthcare coverage, the contribution limit for 2019 is $3,500 per year. If you have family coverage through your plan, the 2019 contribution limit is $7,000 per year.
But what’s so cool about H.S.As? Why should I worry about how much to put in this account?
Two words, tax deduction.
Tax Characteristics
An H.S.A. is the unicorn of financial accounts because of its tax efficiency. They call it the “triple tax threat”. Let’s count the ways.
- Dollars saved into an H.S.A receive a tax deduction (federal & state).
- Dollars, when invested, grow tax-free.
- Dollars distributed from the account for medical expenses are tax-free.
For my tax people out there, you can see why this account is truly one of a kind. There is no other investment account out there with these favorable tax characteristics which makes this account such a valuable planning tool if used correctly.
Ways to Use an H.S.A
Account owners have immediate access to their health savings account and can use the funds to pay for medical expenses via debit card or they can choose to leave the funds alone and invest. Account owners have ability to grow their balances because there is no requirement to spend down the account each year unlike, it’s sister account, Flexible Spending Account (FSA).
As I mentioned, account owners have options on how to utilize their H.S.A. Because there are so many strategies, I wanted to break them down from beginner to advance.
Beginner: Pass Through Method
The pass through method entails funding the H.S.A with just enough money to cover annual medical expenses. By using the account as an intermediary, the owner is clipping the tax deduction up front and paying for medical expenses with pre-tax dollars.
In this scenario, the account balance is zeroed out each year. The pro of this strategy is the tax deduction but the con is eliminating the ability to invest the funds and allow for tax free growth.
Intermediate: Save, Spend and Invest
In this second H.S.A. strategy, the account owner attempts to max out their H.S.A each year and uses the account to pay for medical expenses. In any given year, there is a difference between the funds contributed to the account and money spent on medical expenses. A positive balance will remain in the account and continue to build with future contributions. If the dollar amount is over $1,000, the account owner then has the ability to invest the dollars over $1,000 in the stock market for long-term growth.
The idea here is that the dollars that accumulate in the H.S.A over the years will support medical expenses in retirement. The account holder is going to see their H.S.A. balance grow over time and benefit from compounding interest.
Advanced: Max Fund & Invest
Mastering the H.S.A is when you the financial ability to max out contributions each year and pay for all medical expenses out-of-pocket. This may confuse some as the the primary purpose of this account is to supplement the high deductible and subsidize medical expenses.
Fair, but the best utilization of a H.S.A as a long-term planning tool is to treat this account like a retirement account for medical expenses. With the compounding of interest coupled with a long investment horizon, this account can grow to be hundred of thousands of dollars in retirement. Imagine the medical expenses that amount can cover!
One-Time IRA Rollover
For those of you nearing retirement, this final H.S.A strategy is for you. As an H.S.A. owner, you have the ability to do a one-time rollover from an IRA into the H.S.A. In 2019 this number is $3,500 + $1,000 catch-up if over age 50.
Why take advantage of this planning opportunity?
If you think back to my previous post on retirement benefits, specifically the section on 401(k)s, IRAs and 401(k)s, alike, are funded with pre-tax dollars but are later taxed at distribution. Using this strategy, you have the ability to move $4,500 out of an account that would require taxation at distribution into a H.S.A that does not tax the distribution if used for medical expenses. Depending on the tax bracket of the account owner, this rollover can save thousands on federal and state taxes.
Ideally, this rollover should occur after your age 50 (to benefit from the catch-up provisions) but before age 65 or retirement, whichever comes first. There is a 12 month testing period that account owners must be mindful of before making the rollover. Essentially, the owner must be eligible for an H.S.A for 12 months following the rollover.
As you can see there is no right or wrong way to use an H.S.A, unless you have access to one and don’t use it. Don’t fall into that camp.
Admittedly, while I am a financial advisor, I am still ways away from mastering my personal health savings account. I fall in the intermediate category and do my best to contribute to my H.S.A but still pull from the account to cover my larger medical expenses like glasses and contacts.
I hope this post is enlightening and prompts you to, at a minimum, review your healthcare options and find out if you are eligible to participate in an H.S.A and consider signing up.
Happy Savings!
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