The Underutilized HSA

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Health Savings Accounts have increased significantly over the last ten years. By law, these accounts are so tax-efficient they may be the best investment vehicle available. Then why are we not maximizing their use?

According to America's Health Insurance Plans, the number of participants in HSAs increased from 3.2 million in 2006 to 20.2 million in 2016. Why the HSA craze? Because HSAs pack a triple tax benefit that no other investment account can beat!

That said, the majority of HSA participants don't use them to their full potential. Following are a few tips on maximizing the benefits available in your HSA.

HSA Basics

An HSA allows participants of high-deductible health insurance plans to contribute to a tax-advantaged account earmarked for medical expenses - even expenses not covered by their medical insurance. For 2017, the IRS defines a high-deductible plan as a plan with a deductible of at least $1,300 (individual plan) or $2,600 (family plan).

HSAs accept contributions from both employers and employees. For 2017, the maximum total contribution is $3,400 (individual plan) or $6,750 (family plan). Employees age 55 or older can contribute an additional $1,000 catch-up amount.

HSAs are unique because they provide participants with a triple tax benefit.

  1. Your contributions are tax deductible and employer contributions are not treated as income.
  2. Funds in a HSA grow tax-deferred, meaning all the interest, dividends, and capital gains earned in the account aren't taxable.
  3. There’s no tax on withdrawals used to pay for or reimburse qualified medical expenses.

Can you see now why HSAs are such a great investment tool? Furthermore, HSAs are user-friendly. Most issue a debit card you can immediately use to pay for medical expenses. Unused funds roll over year after year and you never lose what you or your employer contributes to it. Plus, they are portable. No matter whether you switch heath insurance plans, change jobs, or retire, your money will always be available to you.

Using Your HSA to Cover Medical Expenses

The IRS defines eligible medical expenses, i.e. those that can be paid for via the HSA. IRS Publication 502 provides details regarding qualifying expenses. Often health insurers will list eligible and ineligible expenses on their websites.

Some expenses are only eligible under certain conditions. For example, my dentist recommended an expensive electric toothbrush during a recent appointment. After visiting my health insurer’s website, I found the cost of an electric toothbrush was reimbursable - but only if it was submitted with a physician's diagnosis letter. My dentist produced such a letter and I went home with a new toothbrush that I paid for with untaxed dollars!

Be sure to retain those receipts!  Since HSAs fall under the control of the IRS, HSA participants must be able to show receipts for all expenses and distributions. The best practice is to keep all tax-related documents for seven years. It's a pain to keep all those records, but if the IRS audits you, you'll be glad you did!

Using Your HSA as a Retirement Investment

If used correctly, an HSA can become a powerful retirement resource. But, according to the Employee Benefit Research Institute, only 45 percent of HSA participants contributed to their accounts in 2015 and only 3 percent held investments. That translates to thousands of dollars lost over the years.

The IRS specifies that HSA funds can reimburse any eligible medical expenses that have occurred since the HSA was established. One strategy is to maximize contributions to your HSA, invest the funds, and let the account to grow tax-free. Instead of submitting medical expenses for reimbursement from the HSA at the time of expenditure, hold on to them. Once you near retirement, fully reimburse yourself for all the prior expenses. You should have money left in the account for your needs during retirement. However, to make this strategy work, it does require you to pay your medical expenses out-of-pocket when incurred.

One important rule to make note of is that Medicare enrollment ends HSA eligibility. If you reach age 65, remain employed, and are covered under your employer’s health plan, you can delay enrollment in Medicare and continue saving to the HSA. HSA participants are able to make a pro-rata contribution in the year they enroll in Medicare. These transitions can be tricky, so don’t be afraid to seek professional help.

Summary

It's easy to see why health insurers and employers are attracted to HSAs. Their triple tax benefits can make them a more powerful savings vehicle than your 401(k), IRA or Roth IRA. But that only works if you take full advantage of the exceptional benefits available within an HSA.

Kate Arndt is a Financial Planning Coordinator with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at bedelfinancial.com or email Kate.

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