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Maximizing the Benefits of a Health Savings Account

5 Mar 2024

Maximizing the Benefits of a Health Savings Account

Imagine someone told you there was a tool that allows you to make contributions that reduce your taxable income, accumulate tax-free earnings, and make tax-free distributions if they are used for qualified health expenses. Sounds pretty good, doesn’t it? The triple tax benefits of a health savings account (HSA) should not be easily overlooked during your next benefit enrollment window. 

It is important to note that to qualify for an HSA you must participate in a high deductible health plan (HDHP). This is one drawback that must be carefully considered before you elect to participate. With a HDHP you will have a lower premium but higher deductible that will need to be covered out of pocket when medical expenses are incurred. So, if you decide to participate in a HDHP you will need to adjust your emergency fund savings accordingly to prepare for this potential expense. You also cannot be claimed as a dependent or be covered by any other health plans, including Medicare. 

HSA Contributions

The maximum contribution amount will depend on if you are participating in a single or family plan. In 2024 the contribution limit is $4,150 for a single insured person and $8,300 for family plans. At age 55, you are eligible to make an additional $1,000 catch-up contribution to your HSA annually. Like we mentioned earlier, the contribution made into a health savings account reduces the employee’s taxable income. It is important to keep track of money contributed to the plan throughout the year and stay within the contribution limits. Excess contributions to your HSA would not be tax deductible and would also incur a 6% penalty. 

Both employers and employees can contribute to the health savings account. Any contributions you make directly from your paycheck are pre-tax, meaning they reduce the amount of taxable income you have for the year. Any employer contributions, regardless of whether it is a flat contribution or match, are immediately vested but do count towards your annual contribution limit.  

From the employer’s perspective, offering and contributing to an employee HSA as part of a comprehensive benefits strategy can be useful to attract quality talent in a competitive market. Additionally, the contribution or match made to the employee’s HSA is a deductible business expense to the company.  

If you are enrolled in a high deductible health care plan but your employer does not give you direct access to a Health Savings Account, you can still open one. Numerous companies, such as HSA Bank and Optum Bank, will allow you to open an individual HSA without being attached to a group benefits plan. In these cases, you would not have HSA contributions directly withheld from your paycheck – you would simply transfer money from your bank account to your new HSA account. Similarly, your employer may not necessarily make any contributions to your HSA at all. At the end of the year, you would claim your HSA contributions as a deduction when you file your income tax return. 

Using Your HSA

HSA funds can be used to pay for medical supplies, drugs, and services that the IRS (Internal Revenue Service) deems as “qualified.”  There are plenty of expenses that are considered qualified HSA expenses such as medical treatments, dental treatments, vision, some medical costs incurred during travel, some pre- and post-partum care, certain insurance premiums like long-term care, COBRA and more. To find out if the distribution will qualify as an HSA medical expense we recommend checking IRS publication 502 or with your HSA bank 

HSA accounts come with a debit card, and you can choose to pay for drugs or services with that card or pay out-of-pocket and then get reimbursed with funds from your HSA account. Any distributions made for non-qualified medical expenses will be taxable and you could possibly have a 20% penalty if under age 65. Once you reach age 65, a non-qualified distribution would no longer have the penalty but would still be taxable. 

There is no time limit on when you must spend the funds in an HSA. They are your funds and can be accessed at any time. Any unused funds at the end of the year will roll over indefinitely.  

One strategy to consider is maximizing your HSA especially in the years leading up to retirement. Not only are these typically some of your highest earning years, but you are heading into the retirement phase of life where healthcare costs can average approximately $6,000 annually. The ideal option for many HSA owners is to contribute as much as possible annually, but not spend any of those saved dollars on medical expenses during the year, choosing to wait to spend those dollars in many years or decades in the future. This allows for a greater period of tax-free growth.  This strategy is not always possible, of course. If you do spend the money saved within the HSA in the same year you make contributions, you have still used pre-tax dollars instead of after-tax dollars, so there is a tangible benefit – it’s just not as large. 

Another point to keep in mind is that inflation for healthcare typically runs higher than normal expenses at 5-6% a year. Not only is an HSA beneficial during the contribution period by reducing your tax bill, but utilizing an HSA to help prepare and mitigate some of the anticipated healthcare costs during retirement can be extremely beneficial as well. As a retiree, sometimes there is a coverage gap between your retirement date and Medicare enrollment. Not only can HSA funds be used to help with large one-off medical expenses, but you could also use them to help cover certain insurance premiums like COBRA or some medical plan deductibles, which can help you bridge the coverage gap.  

Once you enroll in Medicare, typically at age 65, you are no longer eligible to make additional contributions to your health savings account. However, the funds in your HSA are still available to be used for medical expenses – including paying Medicare premiums! This option is very nice if you sign up for Medicare but choose to defer starting your Social Security benefit. 

Another tool available is the ability to invest contributions within your Health Savings Account. Similar to employer retirement plans like a 401k, there will be a list of available investment options to choose from with your HSA provider. Investing the funds in your HSA provides the possibility of generating more capital appreciation on the funds rather than just leaving them in cash. We recommend discussing the investment options with your financial planner to determine which vehicles and risk level are best for you.  

One final option to mention is that you can make a once-in-a-lifetime contribution to your health savings account from your Individual Retirement Account (IRA)? Even though you are pulling from an IRA, these funds are not taxable as ordinary income and avoid the 10% early withdrawal penalty. The amount you can add into your HSA from the IRA is still limited to the annual contribution caps. This one-time option can be a helpful resource to maximize HSA savings for medical expenses without having to tap into other retirement savings that could incur taxes and potentially penalties as well. 

Health Savings Account Highlights

  • Must have a high deductible health plan in order to participate in an HSA. 
  • Triple tax benefits – contributions reduce taxable income, earnings are tax-free, distributions for qualified medical expenses are tax-free. 
  • Non-qualified distributions are taxable and may have a 20% penalty. 
  • Eligible for an additional $1,000 catch up contribution at age 55. 
  • Cannot make additional contributions once enrolled in Medicare. 
  • You can select investment options in your HSA to help further capital appreciation. 
  • No time limit to utilize funds in an HSA. 

A Health Savings Account can be a powerful tool for saving and preparing for future healthcare expenses. With its triple tax benefits and flexible options for contributions and distributions, an HSA offers individuals the opportunity to lower their taxable income while building a savings fund specifically designated for medical costs. It is important to carefully consider your eligibility, contribution limits, and investment options when utilizing an HSA, as well as the potential consequences of non-qualified distributions. However, with proper planning and strategic use, an HSA can be a valuable asset in both the present and future for managing healthcare expenses. Collaborate with your financial planner to determine if an HSA is right for you and how to best incorporate it into your overall financial plan. 

 


Please remember to contact BentOak Capital (“BentOak”), in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you want to impose, add, to modify any reasonable restrictions to our investment advisory services, or if you wish to direct that BentOak to effect any specific transactions for your account. A copy of our current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request or at www.bentoakcapital.com. 

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. 

Securities offered through LPL Financial, Member: FINRA/SIPC. Investment advice offered through BentOak Capital, a registered investment advisor and separate entity from LPL Financial. 

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More about the author: Madison Wallace