The health savings account (HSA) is one of the most underrated tools for financial planning. They provide powerful tax benefits that can save families thousands of dollars.
Unfortunately, there are limitations on HSA contributions and participation. These accounts were meant to cover out-of-pocket costs, so account holders must be enrolled in a high deductible health insurance plan. Annual contributions are capped at $3,850 for individuals and $7,750 on family plans this year, so the potential benefits are somewhat modest.
Nevertheless, if you qualify, the perks are worth it -- and they don't stop with tax savings. These four features make HSAs even more useful than you might realize, if you qualify.
1. An HSA can be used as a retirement account
The HSA is designed to incentivize saving for medical expenses by side-stepping taxes, and that's its most popular feature. However, these accounts offer flexibility that can be very attractive to retirees. Non-qualified HSA distributions refer to withdrawals that aren't used to cover healthcare. The IRS doesn't want people abusing HSAs, so these distributions carry a 20% penalty in addition to applicable income tax.
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That penalty doesn't apply to people who are 65 or older, however. Once you reach retirement age, assets in an HSA can be accessed with the exact same tax treatment as assets in a traditional IRA or 401(k). Obviously, there's still a tax incentive to earmark these assets for medical care, but the elimination of penalties for seniors should encourage people to utilize HSAs. You don't have to worry that your hard-earned savings will be inaccessible without incurring a steep penalty.
2. An HSA can deliver growth
Assets held in an HSA can be invested. Depending on the plan's custodian, account holders can use funds to buy mutual funds, ETFs, or individual securities, much like an IRA, 401(k), or brokerage account. That's an excellent feature for people who don't expect to incur significant medical expenses in the foreseeable future. Young savers, for example, might not see much value in an account that's dedicated exclusively to healthcare costs. However, it doesn't have to be a low-growth money pit. An HSA can grow just like your other accounts, then it can be accessed further down the road -- on favorable terms -- when you start a family or experience an unexpected health event.
That said, not everyone should aggressively allocate their HSA funds. Equities, especially growth stocks, are inherently volatile in the short-term. A diversified stock portfolio might deliver reliable long-term returns, but there's no guarantee that your account value will rise every year. As such, you don't want to rely on volatile assets to cover expenses that might require cash in the near term. It's not a great idea to convert stocks into cash when they're temporarily down.
Make sure that your HSA has a balanced allocation, and these accounts should usually reflect a relatively short time horizon. This will ensure unexpected market volatility doesn't wipe out your savings when you need cash to cover medical expenses.
3. A broad range of expenses qualify
When most people think about healthcare expenses, their mind goes straight to doctor's visits and trips to the ER. Those events certainly take place from time to time, but medical costs are a much broader category. The IRS recognizes that fact, and it allows for tax-free withdrawals from HSAs to cover a wider variety of treatments than most people realize.
Some of the less obvious qualifying expenses include:
- Sunblock
- Acne creams and medications
- Fertility treatments
- Alternative medicine like acupuncture, massage, and chiropractor work
- Substance abuse programs
- Smoking cessation products
- Weight loss programs
- Psychiatric treatment
- Family planning and feminine care products
- Eyeglasses
- Emergency transportation
- Travel for medical care
It's a good idea to confirm that specific expenses qualify if you're uncertain. Regardless, it's important to recognize that HSAs aren't just meant to cover major healthcare costs in the event that you're stricken by a serious illness or injury. We all incur minor regular costs to maintain our health, and most people don't take full advantage of the available tax benefits.
4. There's no income limitation on HSA participation
Some tax-advantaged accounts limit participation by income. The Roth IRA, for example, is not available to single people making more than $153,000 or joint filers earning over $218,000. There's no such limitation on HSAs, so it provides a rare tax benefit on investment growth for high earners.
