Health Savings Accounts have been a great addition to the American health care system that help to encourage individual responsibility through a tax advantaged account.
During the Presidential campaign and after the elections the U.S. health care system has been the topic of intense debate over the question, “who should bear the burden of healthcare?” While the Republicans have the majority in congress and control the White House, we would expect that they will get a new health care bill passed to repeal and replace Obamacare. Who knows if they have the spine or gumption to make it happen. I’m not going to hold my breath. Despite the gross incompetency from those on the Hill, years ago they somehow managed to include a little known piece of legislation that is an amazing benefit for the American people known as an HSA or Health Savings Account.
What is a Health Savings Account?
A health savings account (HSA) is a tax-advantaged savings account set aside for medical expenses and is available to U.S. taxpayers who are enrolled in a high-deductible health plan. The money contributed into the account are not subject to federal income tax upon deposit and unlike their sister plan, flexible spending account, HSA funds accumulate year to year and rollover if they are not spent. Health Savings Accounts are owned by individuals not by their company or employer like other plans, which means they are portable if you leave your current employer.
HSA’s were enacted as part of the Medicare Prescription Drug, Improvement, and Modernization Act, and was signed into law by President George W. Bush on December 8, 2003.
There is some confusion about these accounts and from my experience, most people don’t understand the huge benefit and opportunity that lies in these savings accounts.
Here are a few things you need to know about Health Savings Accounts:
1.HUGE Tax benefits
This is my favorite benefit of these accounts. As far as tax advantages, there is no other account that legally gives you TRIPLE tax benefits. That’s right I said triple. Here’s what I mean. If you have an employer sponsored 401k plan, you contribute on a pre-tax basis meaning those contributions go into your retirement account before taxes are taken out. So if you make $4,000 in monthly salary, your 401k contribution of $500 goes into your account before the government takes their piece. This means that you are now taxed on $3,500 instead of $4,000. When you retire many years later and you begin to withdrawal from your 401k plan you are taxed on that money that you contributed because you never paid taxes on it. Here’s the difference with an HSA account. You contribute on a pre-tax basis just like the 401k, lowering your taxable income. But when you take money out for qualified health expenses, you don’t pay taxes on the withdrawals. What’s more, HSA’s allow you to invest your funds into index and mutual funds to unleash the power compounded growth. Contributions plus compound interest can build up quite a nice nest egg for health care expenses in retirement. And guess what, that compounded growth isn’t taxable either. That’s right, the growth isn’t taxable. So that is three tax benefits, no tax on the contributions, no tax on the withdrawals and no tax on the growth. As an investment vehicle, HSA’s have more tax advantages than most retirement accounts. Simply Amazing, isn’t it?
2. Prep for your Retirement
In case you haven’t noticed already, we at thecashflowdude.com are huge proponents of health savings accounts. It is the best tax-free investment type account you’ll find anywhere. It is your money, it is portable, and the money is shielded from taxes on contributions going into the account, deflects taxes as interest compounds, and no taxes when you withdraw it. There is one caveat, it must be used to pay for medical expenses.
So if you are someone who has already maxed out your 401(k) and IRA contributions, the next place to dump some cash is into your health savings account. If you are smart and budget well, with a mere 2.5% rate of return, you could sock away $360,000 over a 40 year career. Of course you and I both know that “the market” has averaged close to 7% annually. So over the same period, that number jumps to just over $1.1 million with no withdrawals.
There has been talk that with the new healthcare bill, the contribution limits may be raised even higher. And that is hands down the best investment vehicle to pay for health care costs in retirement.
3.High Deductible Plans
So with all the great benefits of HSA’s, why don’t more people have them? The short answer, the perceived disadvantage of out of pocket costs. In order to have a health savings account, you need to have a high-deductible insurance plan which typically have a lower monthly premium but require you to pay out of pocket first before your insurance pays. HSA can be used to pay deductibles and doctors visits and other qualified health care expenses (including dental, vision or other health services not covered by your insurance). The remaining funds can be invested in mutual funds, just like a 401(k).
There is another plan that we’ll discuss in another post, called flexible spending account, that is used with high deductible plans. The biggest difference is that FSA accounts require that you spend your funds in a calendar year. With a HSA you don’t need to spend your funds every year, they rollover to the next year and is yours to grow and keep year after year, even if you leave your employer.
Should you stop reading this and enroll in a Health Savings Account? Yes. Most employers don’t allow you to make changes to your insurance until annual enrollment at the end of the year. If you are relatively healthy and are good with your money, you should seriously consider the HSA. It is the best tax advantaged account you’ll ever own.