In the world of financial advice, you often hear conflicting opinions. One expert disagrees with another, and the everyday consumer has no idea who to trust. But in the midst of all that disagreement, there is one financial tool that everyone universally agrees is amazing – the Health Savings Account.
Health Savings Accounts (HSAs) allow you to make tax deductible contributions to an account that you can use to pay qualified medical expenses or let grow tax free. The only major requirement you must satisfy in order to qualify for an HSA is obtaining coverage under a high deductible health plan. For 2015, a high deductible would be a minimum of $1,300 for self-only coverage or $2,600 for family coverage. Maximum contributions for 2015 are $3,350 for individuals and $6,650 for families.
So why are these accounts so great? HSAs allow you to deduct medical expenses are often below the threshold for itemized deductions or provide supplemental contributions to a tax-advantaged retirement account. Let me explain a little further:
Deduct More Medical Expenses
Every year in my tax practice, I see people who go to great lengths to gather information about their medical expenses from the previous year. And many times, even if it is a significant amount, it’s not enough to help them tax wise. In order to take an itemized deduction for medical expenses, the total amount from the year must be more than 10% of your adjusted gross income.
For example, a couple has a new baby and as a result faces abnormally high medical expenses for the year of $10,000. But their adjusted gross income is $200,000. So even though their medical costs were substantial ($10,000), they cannot take a deduction because the expenses were not over 10% of their adjusted gross income ($20,000). Alternatively, if the couple contributed to an HSA, they could take a $6,650 deduction for the maximum HSA contribution that could then be used to partially reimburse them for the $10,000 paid out of pocket. So they essentially get to deduct $6,650 that would be disallowed as an itemized deduction.
Save More for Retirement
This feature is my favorite. Since I am generally healthy and have few medical expenses throughout the year, I keep my contributions invested within my HSA and let them grow tax-free year after year. The funds are there if I need them in the future, and every year I get to take a deduction for my contributions. But I do not plan on touching the money until I am 65 when you can take distributions for any purpose penalty free, which essentially makes the account exactly like a Traditional IRA. Contributions are currently deductible against taxable income, and distributions are taxed as ordinary income.
Medical distributions are always tax free, and I’m sure that once I’m over 65 my annual medical expenses will be much greater than they are now. So distributions to cover medical expenses will always be the best use of HSA funds, but it is also nice to know that you can use the account as a supplemental retirement account if you are generally healthy and have few medical expenses.
If you already have a high deductible health plan, you really should consider opening an HSA. Check with your insurance provider to see if you are eligible. If not, it may be worth reevaluating your plan to see if a high deductible makes sense for your overall health and financial situation. Also, see if your employer sponsors an HSA plan as a part your employee benefits package. They may even make tax free contributions on your behalf.