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HSAs: The Ultimate Tax-Advantaged Account for Your Portfolio

Updated on September 14, 2020 Updated on September 14, 2020
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Health insurance is costly and complicated. A Health Savings Account (HSA) carries many tax advantages and helps fund those expenses. Learn how to use yours the right way and reap the benefits. In short, if you want to uncover how an HSA helps you pay less in taxes while saving for retirement, you’ll love this post.

Face it: We spend our own money differently than we spend other people’s money.

When your insurance covers everything but your $10 co-pay, you don’t ask too many questions. But when it’s your money on the line, you suddenly want to know the justification behind all your health care costs.

You want the generic prescription at a fraction of the price of the name brand. In bad situations, you might even forgo an important procedure just because it costs too much.

The good news is you might start looking after your health a bit more carefully. This has forced transparency in what has traditionally been a very murky world, and sunlight benefits us all.

But even with this newfound transparency, medical bills are still the leading cause of bankruptcy in the United States.

Doctors’ offices aren’t yard sales; we can’t bargain the prices down to an agreeable rate. What we can do is whittle them down from the other end by paying with tax-free money via Health Savings Accounts.

How Do HSAs Work?

What Is an HSA?

Simply put, an HSA is a tax-advantaged Health Savings Account for your medical bills. To qualify, you must have a high deductible health plan (HDHP).

If you prefer conservative growth, you can earn interest like you would with a traditional bank account.

If you prefer to invest your savings, many HSAs allow investment options. Young investors can choose riskier investments now to create a bigger payout in retirement.

And if you like the idea of investing, but still depend on the money in your account to cover your medical bills, you can always invest with the Golden Butterfly strategy.

Golden Butterfly Portfolio

This portfolio is a modified version of the Permanent Portfolio with one additional asset class. This is done to incorporate some of the characteristics of a few other notable lazy portfolios.

 

HSA Taxation

Why would you put your money into an HSA instead of a traditional bank or brokerage account? You wouldn’t want to limit what you can spend your money on, right?

Wrong.

HSAs are often regarded as the best tax-savings accounts because they are triple-tax advantaged. No other savings or retirement account has that many tax benefits.

Your money goes in tax-free, grows tax-free, and is spent tax-free! HSAs are flexible, but they have to be spent on qualified medical expenses. More on that later.

Once you open an HSA, all of your medical costs are fair game, but you have options for how you pay for them.

Paying with Your HSA

The first and simplest option is to pay your bills directly through your Health Savings Account. For example, if you have an account with Lively, you can maintain a balance and pay with a debit card on the spot.

You can also pay online through their bill payment system if you need time to transfer money to your account.

The second and more complex option is the reimbursement method. You can pay for your health care expenses outside of your HSA and then pay yourself back later, even if that means putting the money in and immediately withdrawing it.

Moral of the story? It doesn’t matter when the HSA funds go into your account. As long as you incur the expenses after you open the account, you’re good.

You’re only getting a tax advantage if you contribute to the account, so make sure you’re contributing at least the cost of your medical bills.

What’s even better is there’s currently no time limit to reimburse your expenses, so you can treat it as a tax-free emergency fund or retirement account.

If you’re growing your funds through an investment account, you can keep them there. You can reimburse yourself 10, 20, or 50 years from now (tax law changes excluded). It’ll still be tax-free, regardless of what you spend it on.

HSAs and Retirement

Let’s say you regularly contribute to your HSA and never reimburse yourself. Think of all the medical expenses from pregnancy, routine visits, and various health scares you could accumulate.

When you retire and are faced with presumably lower taxable income, you can withdraw that tax-free money. Congratulations, you just gave yourself a completely tax-free retirement account. To the extent of your unreimbursed medical bills, of course.

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What Expenses Can You Use an HSA For?

hsa-glasses

Once you put money into your HSA, you can spend it on medical expenses for yourself, your spouse, or any tax dependents for the rest of your life, tax-free.

Should you leave or lose your job, you can use your HSA to pay for COBRA premiums, and once you reach 65 you can use it to pay some of your Medicare premiums.

HSAs cover a multitude of medical expenses. Examples of popular expenses include:

  • Dental treatment (except teeth whitening)
  • Glasses
  • Laboratory fees
  • Long-term care
  • Non-cosmetic surgery
  • Prescription drugs
  • Routine physical exams
  • Travel expenses for medical treatment

It’s also important to understand what an HSA does not cover. To get a feel for what your HSA doesn’t cover, the following is a sample of non-qualifying expenses:

  • Gym memberships
  • Hair transplants
  • Most health insurance premiums
  • Vitamins and supplements
  • Weight-loss programs

A good rule of thumb is that anything that’s medically necessary and goes through a medical professional is probably covered. If it’s optional or doesn’t have a prescription, it’s probably a no-go.

For more details on qualifying medical expenses, check out our podcast guests at Ask Mr. HSA.

HSA Rules

Who Qualifies

The IRS has four requirements you have to meet to be eligible for an HSA:

  • Your health insurance is a high deductible health plan (HDHP)
  • The HDHP is your only health insurance
  • You don’t have Medicare
  • You aren’t a dependent for tax purposes

Generally speaking, individuals have an HDHP if your minimum deductible is no lower than $1,400 and your maximum deductible with out-of-pocket costs is no higher than $6,900.

For families, which are considered as having at least two people, these numbers are $2,800 and $13,800, respectively.

Penalties and Taxes

If you’re under age 65 and take money out of your HSA to spend on non-health care purchases, it’s taxed at your normal income rate. Plus, there’s a 20% penalty. But you do have that option.

Once you reach age 65, you can use it for any expenses without penalty. You will pay income taxes at the prevailing tax rate, which should be lower than it was during your prime earning years.

But don’t worry. Your medical bills paid through your HSA will still be tax-free after you reach age 65.

You’ll report your HSA contributions and distributions using Form 8889 on your tax return regardless of whether or not you have a penalty.

Starting and Contributing to Your HSA

If you’re self-employed, you can set up an HSA for yourself. Just buy a plan that’s HSA-qualified and you can reap the rewards available to the rest of us wage slaves.

About 20% of the offerings on the Health Insurance Exchange are HSA-eligible, so you’ll have several to choose from.

If you’re an employee, your employer may have an HSA provider they work with, and you can set up an account with them. If your employer doesn’t offer this – or if you don’t like the HSA provider they use – you can set up an account yourself for free.

Regardless, your HSA belongs to you, not your employer or insurance company. You won’t be able to contribute to it if you no longer have an HDHP at a new job, but it will always be yours.

Not only are HSAs the ultimate tax-savings tools but they also 100% belong to you.

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Your employer can contribute pre-tax money that isn’t deductible, or you can contribute with post-tax money and deduct it on your tax return.

HSA Contribution Limits in 2020

The contribution limits change from year to year. In 2020, a single person can put $3,550 into an HSA and a family can contribute $7,100. If you’re over age 55, you can put an additional $1,000 into your account as a catch-up contribution.

These are annual limits, but you have until April 15 of the following year to contribute. This means that from January 1 to April 15, you have the option of contributing to your HSA both for the current year and the prior year.

Our podcast guests advise first funding the matching portion of your 401K, then fully funding the HSA, and finally going back to the 401K.

You’re not the only one who can contribute to your HSA. You, your employer, and random strangers can put money into your account, but the sum of all these contributions has to be under the annual limit.

And if your grandma gives you HSA money, you still get to claim the tax deduction.

If you started your HDHP during the year, you’re in luck. As long as you started it by December 1, the taxman deems that you had coverage for the entire year.

So if you’re an individual and only started coverage on December 1, you can still put the entire $3,550 into your account. The only requirement is that you maintain the HDHP coverage through December 31 of the following year.

Health Savings Account vs FSA

An HSA should not be confused with an FSA (Flexible Spending Account). FSAs are usually much more strict than HSAs, but they don’t require an HDHP. Unfortunately, you cannot have both an HSA and an FSA, so choose wisely.

There is no expiration date on your HSA balance. FSAs are use-it-or-lose-it plans, so you lose any account balance at the end of the year. It’s not refunded to you. It’s just gone.

Some plans allow the prior year’s balance to cover expenses incurred up to 2.5 months after the end of the plan year. Other plans allow you to carry over up to $500 to the next year. But you can’t have both.

So while HSAs require careful planning to create the ultimate retirement account, FSAs require planning to make sure your hard-earned money isn’t wasted.

Because FSAs are employer-sponsored benefits, self-employed people aren’t eligible for them. Employees agree to an amount they’d like to set aside for their FSA, and their employer withholds this as a payroll deduction.

For 2020, the contribution limit is $2,750 per employee. Your employer can also contribute to your account, but this does not impact the annual limit amount.

The good news is these FSA contributions are tax-free, just like HSA contributions. They also define qualifying medical expenses the same way that HSAs do.

To pay for medical expenses, you will be reimbursed from your plan by submitting proof of both the occurrence and amount of the expense.

Some plans might even come with a debit or credit card that you can use, which will both provide your proof and automatically ensure that you’re making a valid purchase.

Unlike HSAs, you don’t report FSA contributions and reimbursements on your tax return.

In Conclusion

If you’re interested in a Health Savings Account, speak to your HR department and see if a health insurance plan with an attached HSA is available to you.

Whether or not they’re partnered with an HSA provider, you can set up a free account with Lively. It comes with debit cards, online bill pay, no minimum balance requirement, and investment options through TD Ameritrade.

For FAQs and more detailed information on HSAs, our podcast guests Ask Mr. HSA have you covered.

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Caitlin Ward - Contributor Caitlin Ward works as a tax accountant at a small-town Virginia CPA firm. When she isn't writing about personal finance, she's studying for the CPA exam. She has a B.A. in Business Administration and a slight obsession with all things money. She contributes to Listen Money Matters to share what she's learned with more than just her husband and their cats.
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