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Using Health Savings Accounts Wisely

Roger Young, CFP®, Senior Financial Planner

Key Takeaways

  • Health savings accounts (HSAs) are rightfully viewed by financial planners as a powerful retirement savings tool with unmatched tax benefits—if used properly.
  • Savers should consider a range of short- and long-term strategies with HSAs—and avoid situations where they can be suboptimal or even harmful.
  • Eligibility for an HSA requires a high-deductible health plan, so individuals need to evaluate health coverage factors before seeking the tax benefits of the HSA.

Since 2004, individuals enrolled in high-deductible health plans (HDHPs) have been able to fund HSAs. A Mercer survey showed 80% of large employers (20,000 or more employees) offered HSA-eligible health plans in 2016.1 As more employers offer these plans, HSA usage has grown steadily to over 22 million accounts and $45 billion in assets.2 We expect that HSAs will be a growing part of the health care landscape.

In an HDHP, the insured is responsible for a significant portion of health expenses up front before the insurance company pays. However, HDHPs must also include a limit on participants’ out-of-pocket expenses. Premiums on these plans are generally lower than more traditional, lower-deductible policies. See the chart below for current IRS parameters on HDHPs and HSAs.

Key HSA Facts (2019)3
  Individual Family
Eligibility Under 65 and Enrolled in HDHP
Minimum deductible for HDHP $1,350 $2,700
Maximum out-of-pocket expense for HDHP $6,750 $13,500
HSA annual contribution limits $3,500 $7,000
HSA per-person catch-up contribution limit (age 55) $1,000 $1,000

The HSA is structured with significant tax incentives to choose an HDHP and save or invest for health costs. Proponents of HSAs often refer to a “triple tax benefit”: tax deduction, tax-deferred growth, and tax-free qualified distributions. This essentially combines the benefits of Roth and pretax strategies in an individual retirement account (IRA). In addition, the funds can be used before retirement for qualified medical expenses, without tax or penalty. If used before age 65 for other purposes, however, a 20% penalty is assessed. 

Opening Quote HSAs offer a “triple tax benefit”: tax deduction, tax-deferred growth, and tax-free qualified distributions. This essentially combines the benefits of Roth and pretax strategies in an IRA. Closing Quote

A key consideration in the evaluation of HSAs is the definition of a “qualified medical expense.” In general, expenses that would qualify for a federal income tax deduction are considered qualified. (As you might expect, you can’t double-dip and count them both as qualified for your HSA and as itemized deductions.) Some insurance premiums are qualified: Medicare, long-term care, COBRA, and coverage while you’re unemployed. However, one significant medical premium is not qualified: Medicare supplement insurance, also referred to as Medigap. Hybrid life insurance/long-term care policies are usually considered life insurance and, therefore, aren’t qualified.

A helpful feature of HSAs is that qualified medical expenses from prior years can be used to take qualified distributions. The expenses need to have occurred after you established the HSA and cannot have been otherwise reimbursed or used for itemized deductions.This feature adds to the flexibility of HSAs if you can keep good documentation of medical expenses and tax returns (potentially for a much longer time than you would ordinarily keep those records).

It is also important to distinguish HSAs from other tax-favored health plans: flexible spending arrangements (FSAs) and health reimbursement arrangements (HRAs). Like HSAs, these other plans feature contributions that are excluded from gross income and tax-free withdrawals for qualified medical expenses. However, there are key differences:5

  • FSAs have a lower contribution limit and are generally “use it or lose it.” Only $500 of unused amounts at year-end may be carried over to the next year, if permitted by the employer; other unused amounts are forfeited.
  • HRAs are funded solely through employer contributions, not employee salary deferrals. Unlike HSAs, they are generally not portable to another employer or convertible to cash.

With this backdrop, some of the key questions facing individuals include:
 

  • Should I fund an HSA before my emergency account? Before my retirement plan?
  • How do I choose between the HSA and getting my employer retirement plan match?
  • Should I use my HSA for annual expenses or invest it for the future? How should I invest it?
  • How do I decide between an HDHP and a health plan with a lower deductible?
  • How much is a reasonable amount to put into the account?
  • What level of medical expenses should I expect in retirement?
  • In what order should I withdraw money from accounts (HSA, Roth, pretax IRA, taxable, etc.) in retirement?

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Using HSAs Wisely

Health savings accounts can be a powerful retirement savings tool with unmatched benefits if used properly.

1Mercer National Survey of Employer-Sponsored Health Plans, 2016.

2Devenir Research 2017 Year-End HSA Market Statistics & Trends, February 22, 2018. devenir.com/devenirWP/wp-content/uploads/2017-Year-End-Devenir-HSA-Market-Research-Report-Executive-Summary.pdf

3IRS Revenue Procedure 2018-30.

4Internal Revenue Bulletin 2004-33 Notice 2004-50, Health Savings Accounts—Additional Qs&As, Answer 39, August 16, 2004.

5IRS Publication 969.

Important Information

This material is provided for general and educational purposes only and is not intended to provide legal, tax, or investment advice. This material does not provide fiduciary recommendations concerning investments; it is not individualized to the needs of any specific benefit plan or retirement investor, nor is it intended to serve as the primary basis for investment decision-making.

The views contained herein are those of the authors as of February 2019 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

All investments involve risk. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc., Distributor.

© 2019 T. Rowe Price. All rights reserved. T. Rowe Price, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.

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