The HSA Triple Tax Advantage You Need To Capitalize On.
It’s called the HSA. The Health Savings Account. HSAs are usually offered with qualified high deductible health plans through your employer. The HSA triple tax advantage has, yes, three main tax benefits. The way it works is that money contributed to this account is tax deductible (Advantage 1), grows tax-free (Advantage 2), and can be withdrawn tax free for qualified medical expenses (Advantage 3). Ideally, withdrawals are delayed for reasons you will learn about below.
- The amount you contribute reduces your taxable income for the year, i.e. lower taxes for you this year!
- The money that’s now in your HSA can be invested, and growth and interest on it are tax free (unlike taxes on capital gains, dividends, and interest in regular accounts)! This is a great tax benefit.
- The funds can be withdrawn from your HSA tax free (like a Roth IRA) for qualified medical expenses, which most likely we all have!
- Some employers match contributions up to a certain amount (just like matching in 401ks). This is free money, a no-brainer.
- If you withdraw the money before age 65 for non-medical expenses, you could incur a 20% penalty.
- Because the government grants these tax benefits, it only allows you to contribute a maximum of $3,600 for 2021 if filing individually (and covered individually) and $7,200 if filing married/jointly (and if the plan covers the employee + family). Contributing up to the max ensures you take full advantage of the benefits.
- You can roll over your HSA balance from year to year, unlike Flexible Spending Accounts.
HSA triple tax advantage example:
- You are married, filing jointly, your health plan covers both spouses, you are in the 25% federal tax bracket for 2021, and no state taxes.
- You contribute the max $7,200 for 2021 and deduct it from your taxable income, so it saves you $1,800 for 2021. This is the HSA tax deduction.
- Your out-of-pocket medical expenses for a hospital visit is $500. You pay this out of your HSA, so it comes out tax-free and saves you $125 of taxes, compared to if it were paid for with after-tax dollars, or with a Traditional IRA, where you’d be required to take out $625 to pay the $500 bill, with $125 going to Uncle Sam.
- The remaining $6,700 is invested, grows 5% for the year via long term capital gains only, and is now at $7,035. The $335 of growth is tax-free, a 15% savings of $50 vs. if you were to pay long-term capital gains tax on it.
- If your employer matches up to $500 for the year, then that $500 is a 100% return.
What if you have a qualified HDHP through your employer, but no HSA through the employer? Don’t worry. Many banks offer HSA accounts for this purpose. Still, you might as well bring it up to HR and management and ask why they don’t offer this.
Again, the way to optimize this is to let it grow. That means, assuming you have enough cash in the bank, you should pay for your smaller, current health expenses, such as doctor checkups, prescriptions, and urgent care visits, from your bank account and not from your HSA. Let the HSA grow tax-free and save it for a larger health expense down the road.
What expenses usually qualify? The IRS has a long list in IRS Publication 502, but here’s a few:
- Chiropractor services
- Dental services
- Diagnostic devices
- Surgical expenses
- Fertility treatments
- Hearing aids
- Home care costs
- Laboratory tests
- Long-term care costs
- Prescription medications
- Nursing services
- Psychiatric care
- Eye exams, glasses, and contact lenses
- Medical devices such as crutches and wheelchairs
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