Hans Blake, CFA, CPA

Reading Time: 7 minutes Many Americans either have or are eligible for health savings accounts (HSAs), but many fail to understand their benefits. At Intelligent Investing, our passion is to minimize your financial stress to maximize your life. We hope this HSA guide can help you maximize your HSA. We’ve even thrown in some Intelligent Investing tips at the bottom of the article, so be sure to read those as well.

How an HSA Works

The HSA was created when high-deductible Health Plans (HDHP) came about. The idea was to provide a way to pay for healthcare and not be taxed on it. Money deposited into an HSA is tax-deductible. It then grows tax-free and can be withdrawn tax-free to pay for qualified medical expenses. For 2019, individuals who have single health plans with a minimum deductible of $1,350 and a maximum out-of-pocket cost of $6,750 are eligible for an HSA. For those with family health plans, the minimum deductible for eligible policies is $2,700 and the maximum out-of-pocket costs are $13,500. For 2020, the annual contribution limit to an HSA is $3,550 for individuals and $7,100 for a family. People age 55 or older are permitted to kick in an extra $1,000 each. All deductibles, co-pays and coinsurance for in-network covered benefits must count toward the policy’s out-of-pocket limits. Be aware that the out-of-pocket spending limits to be eligible for an HSA are lower than the limits required for health insurance policies by the Affordable Care Act. So all HSA-qualified plans meet the ACA requirements, but not all ACA-qualified plans meet the HSA requirements.

The Triple Play- The 3 tax benefits of HSAs

If you take advantage of your HSA, as well as the ability to invest your money within it, there’s a unique triple tax advantage to HSA investing that simply doesn’t exist in other tax-deferred investment vehicles. Consider these three points:

1. If you’re eligible to contribute to an HSA, your contributions are tax-deductible up to your annual maximum. For example, if you’re under 55 and have family coverage, contributing the maximum to your HSA for 2019 will lower your taxable income by $7,000.
2. While your money is invested in an HSA, it grows tax-deferred. This is the same tax deferral that occurs in an IRA, 401(k), or another retirement vehicle, meaning that you don’t have to pay annual taxes on capital gains, interest income, or dividends that occur within the account.
3. Withdrawals from your account that are used to pay for qualified health-care expenses are 100% tax-free.

Let’s say you’re 45 and have a qualifying family health plan. If you contribute $7,000 per year to an HSA for the next 15 years, you’ll have excluded a total of $105,000 from your taxable income. At the end of the 20-year period, your account could be worth about $175,000, assuming 7% annualized investment returns — and you’d be free to withdraw this money tax-free to cover any out-of-pocket health-care costs. That’s a $70,000 profit on your investment that won’t cost you a dime in taxes if you use it for qualified reasons. Or you can simply let it continue to grow to give you a huge nest egg for health care in retirement.

Steps to Create an HSA (if you qualify)

To use your health savings investment account as a valuable retirement planning tool, follow these four steps:

• Open an HSA investment account.
• Contribute the maximum allowed.
• Save your receipts and let your balance grow.
• Use your HSA similar to an IRA in retirement.

Open a health savings investment account. 

Bank and credit union HSAs can be convenient for those who plan to spend their money right away on health care expenses. However, because these institutions may offer little to no interest, you may want to look for an alternative provider who will allow you to invest your money for a potentially greater return. Be aware that fees for some investment accounts can be high, so it’s best to read all the fine print and shop around. At Intelligent Investing, we can coordinate your HSA accounts with your overall financial plan and portfolio. If you have a health savings account through your employer, you may not have an option as payroll contributions may need to be made to the provider they select. However, you can later transfer balances to a different HSA.

Contribute the maximum allowed. 

You can contribute up to $3,500 to an HSA if you have single coverage or up to $7,000 for family coverage in 2019. Those who are age 55 or older are entitled to make an additional $1,000 in catch-up contributions. So if you’re at least 55 years old and have self-only health coverage, you can contribute a total of $4,500 to your HSA in 2019. If you’re 55 or older and are the primary insured on a qualifying family health plan, you can contribute as much as $8,000 to your account. Keep in mind that any amount your employer puts into your HSA counts toward the contribution maximum. So if you have family coverage and your employer adds $500 to your account, you’ll be able to contribute the remaining $6,500 for the year. Your contributions can be made until the April tax deadline in any given year. This is generally April 15, but it can differ slightly because of weekends or holidays. Tax deductions made for contributions to a workplace retirement plan (such as a 401k or 403b), may be limited based on income. However, there are no such restrictions on HSA deductions. The entire contribution is deductible regardless of your income.

Save your receipts and let your balance grow

While HSAs are intended to provide a tax-free way to pay for health care costs, you don’t have to use it when you have medical expenses. Let me repeat, you don’t have to use it when you have medical expenses. Instead, you could pay bills out-of-pocket and let the balance in your HSA grow. You could reimburse yourself years later. However, you need to keep good records. We recommend saving your receipts and keeping a spreadsheet of paid qualified medical expenses that can be used for reimbursement in the future. This strategy could be particularly useful for those who want to retire early and need to supplement their income before Social Security payments begin. You can boost your bank account by reimbursing yourself for several years’ worth of previous medical expenses as long as you have documentation to back up the claim should you be audited. If you later change insurance and no longer have a qualified high-deductible plan, you can still pay for medical expenses out of your HSA. However, you can’t make any new contributions until you have a qualified plan again.

Use your HSA similar to an IRA in retirement

Workers who use money from an HSA for anything other than qualified health expenses will incur a 20 percent tax penalty. Yikes! That is in addition to regular income tax that must be paid on the withdrawn amount. Double Whammy! There is no penalty for non-health care withdraws in retirement once you hit age 65. At that point, money can be taken from an HSA for any purpose with only income tax due on that amount (if it wasn’t for a qualified medical expense). HSAs also have an advantage over traditional IRAs. While traditional IRA holders are required to begin taking required minimum distributions (RMDs) at age 70 1/2, there is no such requirement with an HSA.

Other HSA Considerations

Does my enrollment in my employer’s Health FSA affect my HSA eligibility?

Yes. Health FSAs follow many of the same Internal Revenue Service (IRS) regulations as medical plans. When you participate in a Health FSA, you have an additional medical plan. Unless all your coverage is HSA-qualified, you’re disqualified from opening or contributing to an HSA. You can’t open and contribute to an HSA during any month that you participate in a traditional Health FSA, even if you’re also enrolled in an HSA-qualified medical plan and meet all other eligibility requirements.

I lost my job. Can I keep my HSA?

HSA accounts are portable. You own the account no matter your job status or if you leave your employer. You can also use your HSA if you aren’t covered by a high deductible health insurance plan. The funds in an HSA are yours to spend on eligible health expenses, and later, after age 65, may be withdrawn for other reasons without penalty.

Can I pay for insurance premiums (including COBRA) with my HSA?

Generally speaking, most insurance premiums cannot be covered by an HSA; they are not included on the eligible expense list published by the IRS. However, there are a few exceptions. According to IRS publication 969, you can’t treat insurance premiums as qualified medical expenses unless the premiums are for:

1. Long-term care insurance.
2. Health care continuation coverage (such as coverage under COBRA).
3. Health care coverage while receiving unemployment compensation under federal or state law.
4. Medicare and other health care coverage if you were 65 or older (other than premiums for a Medicare supplemental policy, such as Medigap).

So, yes, COBRA premiums can be paid out of your HSA and you can continue coverage. In addition, if you are unemployed and are receiving unemployment compensation, you can purchase other healthcare insurance with your HSA.

Can I contribute to an HSA While on COBRA?

The answer depends on the type of insurance coverage you have while on COBRA. As long as you are enrolled in a qualified high deductible health plan, you can make contributions.

Can I contribute to an HSA before I qualify for Medicare?

If you have an HSA-qualified high deductible health plan, you can contribute to an HSA whether you are working or not. However, be sure your spouse doesn’t have an account, such as a flexible-spending account (FSA), that might disqualify you from contributing.

Does enrollment in Medicare affect my HSA eligibility? 

Yes. Medicare doesn’t offer an HSA-qualified option.

Can I keep contributing to my HSA once I’ve enrolled in Medicare?

No. You can’t make contributions after you enroll in any Part of Medicare, even if you’re also covered on an HSA-qualified plan and meet all other HSA eligibility requirements. So maximizing contributions now will allow the miracle of compounding to work, growing that money in your HSA over time.

Do medical expenses have to be reimbursed in the year they are incurred?

No. As mentioned earlier, the biggest payoff with an HSA comes when the money isn’t used for current medical bills and instead compounds over time. Just be sure you keep your receipts and detailed records. Without proof, the IRA may impose income tax on distributions–and a 20% penalty if you are younger than 65.

Can you reimburse yourself from an HSA for medical expenditures that were deducted on a tax return?

No. That is considered double-dipping.

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