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I have had a few questions surrounding Health Savings Accounts (HSAs) and so I wanted to take the time to give a general overview of the account and how best to utilize them.  HSAs can be complicated nuts to crack in terms of how to use it, what situations makes the most sense to use one, and what benefits you can obtain from investing in an HSA. However, your understanding of these accounts will be greatly rewarded as they are some of the most advantageous accounts available if you’re in the position to use them properly.  With that being said, let’s dive into the ideal situation to utilize an HSA.

Best Situation

The biggest criteria for maximizing the advantages that an HSA offers are having a high income and a healthy family.  Let’s start with income levels and why HSAs are great for higher income individuals and families. One of the biggest advantages of the HSA is its ability to compound your investments, so having the ability to simply contribute funds every year goes a long way towards getting the most from your HSA.  However, what really makes higher income individuals and families a great fit for HSAs is the ability to deduct the contributions from taxes. The max contribution to an HSA in 2019 is $3,500 for an individual and $7,000 for a family with an additional $1,000 catch up contribution if you are 55 or older.  This means that if you contribute the max to your HSA your taxable income could be reduced by either $3,500 or $7,000 as HSA contributions aren’t subject to federal or state taxes. For example, if you’re a doctor and are taxed at the 45% marginal tax rate, by contributing the $7,000 to the HSA it’s basically like someone giving you a gift of just over $3,100 because of the reduction in taxes.  Obviously, having a high income allows you to take advantage of the benefits, but let’s look at the other crucial piece which is health.

Everyone wants to have a healthy family and being in good health means that you’ll be in a great position to take advantage of a High Deductible Health Insurance Plan (HDHP).  In these considerations, being in good health means that nobody covered under the plan has any chronic or expensive medical conditions. This is vital as you must only be covered under a High Deductible Health Insurance Plan in order to have access to the HSA, you can’t be covered under another health insurance plan or a health sharing plan.  Another important facet of staying in good health is that you’ll be able to afford the healthcare you do need without relying too heavily on the funds invested in the HSA. By staying in good health and achieving a high level of income, you’ll have put you and your family in a perfect position to take advantage of the financial benefits of an HSA.

Financial Benefits

While I have gone over the tax benefits to using an HSA, let’s discuss some of the other financial benefits to investing in an HSA.  Because most people simply go with whatever account the company picks you may not realize that you can use your HSA to invest in a variety of funds.  Many of the default options are a savings account, but you are able to invest in low cost mutual funds in order to take advantage of market returns and compounding.  Some companies don’t have the option to invest in those types of funds, but you are able to roll over your HSA dollars into one that does once a year (this can affect payroll deductions through your company, so make sure you’re aware of any consequences beforehand).  Unlike a flexible spending account or other healthcare accounts, your HSA dollars roll over from year to year, so being able to invest it appropriately provides a huge boost in your returns. These investment options means that an HSA can act the same as a 401(k) or IRA account as well as providing tax benefits which leads us to our next benefit…

Health Savings Accounts have extremely valuable tax benefits as they are triple tax free when used for medical expenses.  That means that you receive a deduction in your taxes when you contribute to the account, the funds grow tax free, and you can withdraw them tax free to pay for medical expenses.  This is likely the only triple tax free account you’ll have access to, so if you’re in position to take advantage of an HSA then it’s worthwhile to determine how it fits into your financial plan.  While this is great for any amount of time, these accounts greatly benefit when used to pay for medical expenses years in the future. Because you gave your money time to be invested and compound, using these funds (tax free) in later years can make an enormous difference in your funding of medical care.  HSAs can also be used to pay for Medicare premiums so by preparing now you will be able to make your future medical coverage much easier.

How to Use an HSA

Now that we know when to use an HSA and the financial benefits, let’s talk about how you should look at these accounts as well as some pitfalls you should avoid.  If you’re consistently contributing to this account you may get to a point where you think “I have put a lot away into this account, and it’s generating decent returns, I may not ever be able to use all this for medical expenses”.  If that’s the case then first, congrats on not worrying about healthcare costs! Second, you can actually use the HSA like an IRA in the sense that you can withdraw money at age 65 without having to pay the normal 20% tax penalty. These withdrawals can be spent on anything you like but if they aren’t spent on healthcare they will be taxed at your normal marginal tax rate.  So, like an IRA, it will allow you to take a deduction on contribution and grow tax free which means it will be double tax free. This is still as good as a normal 401(k) or IRA with the possibility of being more tax efficient if spent on medical costs, so HSAs are pretty special. Now let’s look at a pitfall to avoid when using an HSA.

Some of you may be thinking that this would be a great account to leave to your children in order for them to be able to pay for healthcare expenses or receive tax free money, but unfortunately HSAs have very little estate planning protections.  If you pass away and your spouse inherits the account then it still works as an HSA, which is fine, but if it passes to your children or other heirs then significant issues arise. If your HSA is passed to your children, that amount becomes fully taxable the year of your death.  There have been states that are starting to make exceptions for HSAs for estate valuation, but in general there are very few protections for HSAs once you pass away. This is something to be aware of as you look at your long term plans for this account as you’ll want to make use of it while you can.  

Health Savings Accounts can be amazing tools for those in the right position to reduce your medical expense worries as well as give you a triple tax free investment account.  If you are curious about whether an HSA make sense for you then reach out and we can look over your financial picture to see where it can help.  

financial planning for doctors