As if the world of retirement savings accounts weren't complicated enough, there's also the world of health-related savings accounts to consider. Fortunately, despite all the names and acronyms, these accounts aren't too complex for you to master -- and they're well worth learning about, too. A great example is the Health Savings Account, a powerful tool that offers tax relief when paying for health-related expenses while also sporting some retirement-savings features.
One of the first things to know about the Health Savings Account is that to qualify for one, you must have a high-deductible health insurance plan. Your deductible must be at least $1,300 if you're single and at least $2,600 if you have coverage for a family, with out-of-pocket maximums set at $6,450 and $12,900, respectively. You must also not be covered by any other health insurance plan that doesn't have a high deductible, you must not be enrolled in Medicare, and you cannot be claimed as a dependent by anyone on their tax return. If you don't currently qualify, keep reading, because you might find the Health Savings Account compelling enough to want to change your health insurance plan.
The point of a Health Savings Account is to let you avoid paying taxes on many healthcare expenses -- though it can do more than that. Annual contribution limits change over time, but for the 2015 tax year, you can park up to $3,350 in one if your health insurance plan is for a single person and up to $6,650 in one if your coverage is for more than a single person. Those aged 55 and up can tack another $1,000 onto those limits.
Imagine that you contribute $3,000 to one in 2015, and you're in the 25% tax bracket. That money goes into your account before it's taxed -- in other words, you deduct it from your taxable income and thereby avoiding paying $750 in taxes (25% of $3,000). So you get to spend the money on health-related expenses that you probably would have had to pay for anyway, and you can save hundreds of dollars in the process. You will typically have a debit card to use for qualifying expenses, tied to your account. You may also receive blank checks, and you can often pay for expenses on your own and then get reimbursed for them from your Health Savings Account, too.
Finally, a word about withdrawals. The money grows in your account until it's spent on qualified healthcare expenses, but once you turn 65, you are allowed to withdraw it to spend on any expense. It's now basically yours to spend as you wish, though it will be taxed at ordinary income tax rates when not spent on health expenses. (Withdraw funds for non-qualifying health expenses or anything else and you'll get whacked with a 20% penalty charge.)
Not an FSA!
Finally, a word about withdrawals. The money grows in your account until it's spent on qualified healthcare expenses, but once you turn 65, you are allowed to withdraw it to spend on any expense. It's now basically yours to spend as you wish, though it will be taxed at ordinary income tax rates when not spent on health expenses. (Withdraw funds for non-qualifying health expenses or anything else and you'll get whacked with a 20% penalty charge.) Also, at age 65, you're no longer permitted to contribute to a Health Savings Account.
Now that we have that out of the way, here's the next critical detail about the Health Savings Account that you need to understand: It's not the same thing as a Health Flexible Spending Account, or FSA. Although both aim to help you pay for healthcare expenses in a tax-free way, there are a bunch of key differences between the two.
A big difference is that FSAs have a use-it-or-lose-it feature that Health Savings Accounts don't. With an FSA, you can contribute pre-tax dollars (up to $2,550 in 2015) to an account that's earmarked for qualified healthcare expenses. (Employers can contribute, too, but the total allowed is still $2,550.) It used to be that whatever you didn't spend by the end of the plan year would be lost, but that rule has been slightly relaxed, so that you can now carry over up to $500 into the next plan year.
Do so, though, and you will be disqualified from participating in a Health Savings Account in that year you carried the money into. That's an important detail to keep in mind as you plan ahead. (Note that there are a few other kinds of FSAs, for which this rule doesn't apply. It applies to Health FSAs.)
Another difference is that money in a Health Savings Account can be invested in a variety of funds much like you would invest money in a 401(k) or 403(b) account, whereas FSAs don't give you that option. Clearly, the Health Savings Account is generally more appealing than the FSA, but it's easier to qualify for the FSA, as you don't need a high-deductible health plan for it. Each plan therefore has its place.
More powerful than you think
Let's return to our new friend the Health Savings Account now, because you need to appreciate just how powerful it can be. That $3,350 annual contribution limit is a good place to start: It's more than half of the $5,500 that most people can contribute to an IRA in 2015. If you have family healthcare coverage and can contribute up to $6,600 in 2015 to a Health Savings Account, you're exceeding the entire traditional and Roth IRA contribution limit. And remember -- if you're 55 or older, your Health Savings Account contribution limit is even higher, by $1,000. Clearly, we're talking about significant sums here.
Imagine that you sock away just $3,000 annually into a Health Savings Account over 20 years, and that you remain surprisingly health during that period, not tapping your account at all. If that money grows at 8% annually, you'll end up with a hefty account balance of more than $148,000. That will go a long way in retirement -- and if spent on qualified healthcare expenses, it will be tax-free, too. If you averaged annual contributions of $5,000 for 20 years and your money averaged a 10% annual growth rate, your account could top $300,000! This is no rinky-dink little savings account.
Strategies to consider
So how should you use a Health Savings Account? Well, there's a good case for making aggressive use of it. After all, many of us face substantial healthcare costs in our lives today -- and most of us face even bigger ones down the road. The average cost of braces for just one kid is about $6,000 -- which is often paid for with income you've been taxed on, most likely at 25% or more. In retirement, the folks at Fidelity have estimated that a 65-year-old couple will spend $220,000, on average, on healthcare in their retirement. Those are big costs to swallow.
If you can, and if it makes sense given your personal financial situation, consider contributing as much as you can to a Health Savings Account. Even if you don't use much of the money for healthcare expenses, it will remain in the account and accumulate and grow. It will be there for any healthcare needs in retirement, tax-free, or can be used for any other needs, with withdrawals taxed at your ordinary income tax rate. (Note that in retirement, we're often in lower tax brackets, making the tax-deferral aspect of Health Savings Accounts another plus.)
If your employer matches any of your contributions, it's smart to contribute enough to max that out. According to the Kaiser Family Foundation's 2014 Employer Health Benefits Survey, the average employer contribution to Health Savings Account accounts (among companies that made them) was $1,006 for single coverage and $1,744 for family coverage. That's a lot of free money.
One scenario in which a Health Savings Account might not be your best option is if you have extensive healthcare needs now, making a high-deductible health insurance plan less attractive than a more full-featured one. In that case, you might skip the Health Savings Account. On the other hand, if your healthcare expenses now are modest but you think they could become substantial, you might pair a high-deductible plan with a Health Savings Account and accumulate funds in the account that can cover those higher costs, should they materialize. Finally, if you have significant health-related expenses that your regular health plan doesn't cover but that a Health Savings Account would, such as for your teeth, vision, or hearing, the Health Savings Account can make sense. Even acupuncture and massages can qualify, if your doctor prescribes them.
A final consideration is just how you invest the money in your account, as that will lead to your ultimate results. For long-term money, it's smart to favor stocks over bonds, and low-cost broad-market index funds can be your best bet.
Don't be one of the many people who don't know what a Health Savings Account is, because it might be able to serve you very well, either now or in retirement. Learn more about it, and perhaps consult a financial planner to help you decide whether it's right for you.