When it comes to looking at your options for investing, it can be easy to quickly get overwhelmed. It seems like there are dozens of retirement accounts that are all some combination of letters and numbers. However, if healthcare is a big focus in your life or you love tax-advantaged accounts, there is one investment account that you can’t afford not to know about.
This article will examine the benefits of using a health savings account.
What is an HSA?
A health savings account (HSA) is defined as a special type of savings account that lets you save money on a pre-tax basis, similar to a traditional 401k or IRA. The benefit that sets an HSA apart is that you can withdraw funds from the account tax-free to pay for qualified medical expenses. Since you are getting a tax deduction up front on the contributions and can use the untaxed dollars to pay for things like deductibles, copays, and other medical expenses, your overall tax burden could be lower at the end of the year (NOTE: HSA funds are usually not allowed to be used to pay premiums).
In this way, HSAs offer a unique opportunity to save for medical expenses while reducing your taxable income, allowing for tax-deferred investment gains, and providing tax-free funds for medical expenses all at the same time. That’s three tax advantages!
If you are currently enrolled in a high-deductible health insurance plan (HDHP), you will most likely be qualified to enroll for an HSA. However, it is important to note that the IRS is constantly changing the requirements for who is eligible to enroll in an HSA. To find the most up-to-date info, click here.
Now that we have established what an HSA is, let’s take a deeper look at the benefits of using one.
Contributions Are Tax-Deductible
As stated before, you are able to subtract the contributions that you make from your taxable income at the end of the year. This means that HSA’s are a great method to tag team with your 401k to minimize your overall tax burden while putting the money in a valuable place.
If you are someone who ends up paying a lot in medical expenses throughout the year, then you should strongly consider using an HSA to help pay them. Since you are already making healthcare payments anyway, you may as well use an approved account like an HSA to save on taxes at the same time, assuming you qualify for an HSA.
Your Account Can Grow Tax-Free
When you make contributions to an HSA, that money is not sitting idly. Usually, the money above a predetermined threshold can be invested in low-cost mutual funds or ETFs which will give the account an opportunity to grow while you wait to make withdrawals. Interest earnings and capital gains are accumulated tax-deferred, and if you use them to pay for qualified medical expenses, they turn into tax-free gains.
If you make a withdrawal from an HSA before age 65 for a non-medical expense, there is a 20% penalty plus taxes. After reaching the age of 65, there is no penalty for making a withdrawal and not using it for medical expenses. After you turn 65, your HSA acts similarly to a traditional IRA, in that you pay taxes on distributions without a penalty. Knowing this, you can sock away extra funds for retirement on top of your other retirement plans.
You do not need to use the HSA funds for every expense. You get to pick and choose which expenses to use the funds for. Some people will save the receipts of their medical expenses for years, allow their HSA to grow tax-deferred, then withdraw the funds tax-free to reimburse several previous medical expenses. It is powerful!
We hope that you have found this article valuable when it comes to understanding what a health savings account is and what some of the benefits are of using one. If you are interested in learning more, please reach out to us.
Happy New Year!