Health savings accounts (HSAs) are often described as a triple tax-advantaged savings tool because they offer benefits such as tax deductions for contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. They can be a powerful tool for those seeking to save for healthcare costs in retirement. In this article, we will explore the magic of HSAs and how they offer a tax shelter advantage.
What is an HSA?
An HSA is a type of savings account that allows people to set aside money to pay for qualified medical expenses, such as deductibles, copayments, and prescriptions. These accounts are only available to those with high-deductible health plans (HDHPs). Both employees and employers can contribute to an HSA. Contributions are tax-deductible, and the earnings in the account grow tax-free. Withdrawals are tax-free when used for qualified medical expenses.
How do HSAs work?
When you enroll in an HDHP, you have the option to open an HSA. Once opened, you can contribute up to the annual limit set by the IRS. For 2021, the contribution limit is $3,600 for individuals and $7,200 for families. Those aged 55 and older can make an additional catch-up contribution of $1,000.
Contributions are made pre-tax, reducing your taxable income in the year of contribution. The money can be invested in mutual funds, stocks, and bonds for tax-free growth. When you use the money for qualified medical expenses, you can withdraw the funds tax-free.
What are the advantages of an HSA?
HSAs offer several advantages:
- Tax deductions for contributions: Contributions to an HSA are tax-deductible, which reduces your taxable income for that year.
- Tax-free growth: The earnings in an HSA grow tax-free, which means you don’t owe taxes on the money earned.
- Tax-free withdrawals for qualified medical expenses: When you use the funds in an HSA for qualified medical expenses, you can withdraw the funds tax-free.
- Portable: An HSA is owned by you, which means you can take it with you from job to job.
- Long-term savings strategy: HSAs can be used to save for healthcare costs in retirement, providing a long-term savings strategy.
What are qualified medical expenses?
Qualified medical expenses are expenses for medical care that qualify for tax deductions under the IRS tax code. They include:
- Medical, dental, and vision expenses
- Prescription drugs and insulin
- Long-term care services
- COBRA premiums
- Medicare premiums other than Medicare supplement policies
For a full list of qualified medical expenses, visit the IRS website.
What happens if I withdraw funds for non-medical expenses?
If you withdraw funds from your HSA for non-medical expenses, the amount withdrawn will be taxed as income, and you may be subject to a 20% penalty if you are under the age of 65. However, once you turn 65, you can withdraw funds for non-medical expenses penalty-free, although taxes will still apply.
Can I use an HSA for dental and vision expenses?
Yes, HSAs can be used for dental and vision expenses, as long as they qualify as medical expenses under the IRS tax code. This includes things like eyeglasses, contact lenses, and dental fillings.
Can I use an HSA for over-the-counter (OTC) medications?
As of 2021, you can use your HSA to purchase OTC medications without a prescription. This includes things like pain relievers, cold medicine, and allergy medication. However, keep in mind that this rule may change, so it’s important to check the IRS guidelines and your HSA plan documents.
Can I invest my HSA funds?
Yes, you can invest your HSA funds in a variety of investments, including mutual funds, stocks, and bonds. Many HSA plans offer a menu of investment options. However, keep in mind that investing in the stock market involves risk, so it’s important to do your research and choose investments that are appropriate for your risk tolerance and goals.
What happens if I switch to a non-HDHP?
If you switch to a non-HDHP, you can no longer contribute to an HSA. However, you can still use the funds in your HSA for qualified medical expenses tax-free, even if you are no longer enrolled in an HDHP.
Can I have an HSA and an FSA?
You can have both an HSA and a flexible spending account (FSA), but there are some limitations. If you have an HSA, you cannot contribute to a general-purpose FSA. However, you can contribute to a limited-purpose FSA, which is used to pay for qualified dental and vision expenses only. Some employers offer both types of accounts as part of their benefits package.
Can I use my HSA to pay for my spouse’s medical expenses?
Yes, you can use your HSA to pay for your spouse’s medical expenses, even if your spouse is not enrolled in an HDHP. This also applies to dependent children you claim on your tax return, even if they are not enrolled in an HDHP.
What happens to my HSA when I die?
When you die, your HSA becomes the property of your designated beneficiary. If your spouse is the designated beneficiary, the account will be treated as their own HSA. If someone else is the designated beneficiary, the account will no longer be treated as an HSA, and the beneficiary will have to pay taxes on the amount inherited.
Conclusion
HSAs can be a powerful tool for those seeking to save for healthcare costs in retirement. By offering tax deductions for contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses, HSAs provide a tax shelter advantage that can help you save money in the long run. They are portable and can be used for a variety of qualified medical expenses, including dental and vision care. However, it’s important to understand the rules and limitations of HSAs before opening one.
FAQs
1. What is an HSA?
An HSA is a type of savings account that allows people to set aside money to pay for qualified medical expenses, such as deductibles, copayments, and prescriptions.
2. Who can contribute to an HSA?
Both employees and employers can contribute to an HSA. Contributions are tax-deductible.
3. What are qualified medical expenses?
Qualified medical expenses are expenses for medical care that qualify for tax deductions under the IRS tax code. They include things like medical, dental, and vision expenses, prescription drugs and insulin, and long-term care services.
4. Can I invest my HSA funds?
Yes, you can invest your HSA funds in a variety of investments, including mutual funds, stocks, and bonds.
5. What happens if I withdraw funds for non-medical expenses?
If you withdraw funds from your HSA for non-medical expenses, the amount withdrawn will be taxed as income, and you may be subject to a 20% penalty if you are under the age of 65.
6. Can I use my HSA to pay for my spouse’s medical expenses?
Yes, you can use your HSA to pay for your spouse’s medical expenses, even if your spouse is not enrolled in an HDHP.
7. What happens to my HSA when I die?
When you die, your HSA becomes the property of your designated beneficiary.
8. Can I have an HSA and an FSA?
You can have both an HSA and a flexible spending account (FSA), but if you have an HSA, you cannot contribute to a general-purpose FSA.
9. Can I use an HSA for over-the-counter (OTC) medications?
As of 2021, you can use your HSA to purchase OTC medications without a prescription.
10. What happens if I switch to a non-HDHP?
If you switch to a non-HDHP, you can no longer contribute to an HSA. However, you can still use the funds in your HSA for qualified medical expenses tax-free, even if you are no longer enrolled in an HDHP.
