As I sat in my kitchen watching the beginnings of the COVID-19 crisis unfold on a Sunday afternoon, typing on my laptop and reviewing emails from the prior week, I noticed that my television in the background was showing replays of old NCAA championship basketball games. The 1982 game between the North Carolina Tarheels and the Georgetown Hoyas was on and it featured what many would consider to be, myself included, the greatest basketball player of all time. As I watched Michael Jordan, aka “His Airness,” dribble, drive to the hoop, and nail jump shots from every angle of the court my mind wandered and I started thinking about what made him so good and so much fun to watch for all those years. He really was the definition of a “Triple Threat,” and he was a great defender too!
Reflecting on the attributes that made him one of the best basketball players of all time somehow got me thinking about the financial planning equivalent of a “Triple Threat”. I thought about how versatile Michael Jordan was and how he was able to effectively play almost any position on the court. He was seemingly good at everything. My conclusion? The equivalent is a Health Savings Account, or HSA. Let me explain why it gets my vote as one of the best options available to help save for healthcare and retirement planning needs.
An HSA allows you to pay for qualifying medical expenses with pre-tax funds. It is available to anyone insured by a high-deductible health plan (HDHP) that satisfies IRS requirements with respect to annual deductibles and out-of-pocket expenses. An HDHP has a higher deductible than nearly any traditional insurance plan. The monthly premium is lower, but you end up paying more for your health care costs prior to the insurance company stepping in and beginning to cover any expenses. The decision between a traditional policy vs. HDHP is specific to every individual. Total cost, family need, pre-existing conditions, prescription drugs, even household cash flow needs to be considered prior to making any election. It’s also important to mention that the HDHP option may not even be available based on your respective employer’s healthcare offerings. An HSA is also portable, meaning that it belongs to you and can be transferred if you ever change jobs.
For 2020, the IRS defines an HDHP as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. An HDHP total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) can’t be more than $6,900 for an individual or $13,800 for a family. Contributions and deductions are limited to $3,550 for individuals and $7,100 for a family.
The beauty of HSAs, and why I consider them to be a real “Triple Threat,” is outlined below:
- Contributions are made on a pre-tax basis or they are deductible depending on your employment status (W-2 v. 1099). If you are self-employed you can open a plan with a custodian that offers an HSA, fund it with after-tax dollars, and then take a deduction on your annual tax return. This saves you from paying taxes right now and provides immediate savings.
- You can invest your HSA funds. You have a variety of investment options to choose from, and if the proceeds are used for qualifying expenses the growth will never be subject to tax. Be sure you fully understand the amount of risk in your HSA portfolio because sudden shifts in the market could cause you to lose important dollars that are earmarked for healthcare expenses.
- Another benefit of HSAs is that all withdrawals (non-medical) after age 65* are taxed the same as IRAs post 59½. HSA funds withdrawn for non-qualifying medical expenses are taxed at ordinary income rates and the funds can be used for any purpose without restriction or penalty. This creates another opportunity to save for retirement and to cover potential healthcare expenses at the same time. At age 65 an HSA is treated like an IRA.
The most common uses of HSAs are prescription medications, nursing care, long-term care services, dental care, vision care, psychiatric care, surgical expenses, fertility treatments, chiropractic care, and hearing aids. These expenses would be entirely tax-free if used correctly with a qualifying HSA.
*Don’t fall for the pump fake! If you’re under 65 and withdraw money from your HSA without a qualifying medical expense, you’ll face a 20% early withdrawal penalty from the IRS, in addition to any income taxes you’ll have to pay. Many plans even provide an HSA-specific debit card.
Health Savings Accounts are one of the most seldom used retirement planning vehicles, and only about 3% of people that have HSAs invest the balance. This type of account offers significant benefits to clients in higher income tax brackets or business owners that are excluded from 401(k) plans due to discrimination testing. The rules surrounding HSAs are somewhat complex and the penalties for non-compliance are steep; however, the long-term benefits of establishing and regularly funding a health savings account are well worth the time if done correctly.
In some cases, it’s even possible to transfer funds from an IRA to an HSA to be used tax-free for medical expenses, but that’s a story for another day. If you are trying to determine the value or feasibility of an HSA for yourself or for your employees, it’s important to consult a qualified advisor with a history of working with clients on these types of accounts. There is quite a bit of misinformation out there and the real costs and benefits vary drastically depending on the specifics surrounding your respective situation.
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