Most people who are thinking ahead about their finances spend the most time looking at the various retirement plan options that are available. That's natural, because there are so many different options to choose from, and which one you pick can make a huge difference not only to how much you'll be able to save over the course of your career but also how much you'll owe in taxes when you take the money out of your accounts after you retire.
However, there's one type of tax-favored account that doesn't get nearly as much attention as the many different kinds of retirement accounts out there. Health savings accounts aren't used nearly as much as retirement accounts, because you have to have a qualifying high deductible health plan in order to use them. However, if an HSA is available to you, then it's worth you while to take a closer look -- because HSAs have a triple tax-free advantage that you'll have trouble finding anywhere else. Here, we'll look at the three ways that HSA contributions can save you on your taxes.
1. Contributions are tax-deductible when you make them
The most obvious benefit that HSA contributions give you is an upfront tax deduction for the amount that you contribute. For 2019, you can contribute up to $3,500 to an HSA if the associated high-deductible health plan covers only yourself, or $7,000 if you have family coverage. Those numbers are slated to go up to $3,550 and $7,100 respectively for 2020, and you can contribute an extra $1,000 if you're 55 or older.
You don't have to save the maximum in order to use an HSA, so don't let those numbers intimidate you. Nevertheless, if you can find a way to max out your HSA, then it'll allow you to take full advantage of all the tax saving opportunities health savings accounts offer.
2. Tax-deferred growth as long as the money stays in the account
Many people get confused with HSAs, because they tend to be afraid that they'll have to use their money quickly or else forfeit it. Those are indeed the rules for a similar account known as a flexible spending account or FSA, which generally force you to spend all or nearly all of what you put into the account.
HSAs allow you to keep money in the account as long as you want, and that puts time on your side in terms of maximizing your long-term investment returns. Just because you have medical expenses doesn't mean that you have to use your HSA money to pay them, and leaving your investments untouched inside the health savings account gives you the maximum time possible to avoid taxes on income and gains.
3. Tax-free withdrawals for healthcare expenses
Finally, the real payoff from HSAs comes when it's time to spend your money. As long as you use the health savings account money for qualifying healthcare expenses, then those withdrawals are tax-free. You won't pay any taxes either on the money you initially contributed or on the investment gains that those assets generated over the course of the account's existence.
It's because of that combination of favorable tax attributes that many advisors suggest keeping your HSA money intact as long as possible. Because retirement often comes with a host of medical expenses, there'll usually be ample opportunity to spend down your HSA after you retire. The longer you wait, the more tax-free growth you'll be able to generate.
Keep your HSA healthy
Health savings accounts don't get the attention that retirement plan accounts do, but HSAs have advantages that most retirement accounts can only dream of. If you're eligible for an HSA, be sure to consider all the tax savings that these accounts can produce when you decide whether to participate.