If your goal is to save money in a tax-advantaged fashion, you have several options at your disposal. You can put money into a traditional IRA or 401(k) and snag a tax break on your contributions to either retirement plan. Or, you can fund a Roth IRA or 401(k) and benefit from tax-free withdrawals in retirement. But if you're looking for a savings option that offers the maximum tax value, you may want to consider a health savings account (HSA).
How HSAs work
An HSA is a dedicated account you can use to pay for immediate and long-term healthcare needs. HSA funds never expire, so there's little risk in funding an account. Any money you don't use in the near term can be invested and carried forward so that it's there for you once the need arises. In fact, many people with HSAs use those accounts to sock away money for healthcare during retirement, when it tends to be extremely burdensome and expensive.
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To contribute to an HSA, you must be enrolled in a high-deductible health insurance plan. The definition of that changes from year to year, but in 2020, it's a deductible of $1,400 or more for individual coverage, or $2,800 or more for family coverage. Your health plan must also have an out-of-pocket maximum that does not exceed $6,900 as an individual, or $13,800 at the family level.
Provided you meet these requirements, you can contribute up to $3,550 to an HSA this year as an individual, or up to $7,100 on behalf of your family. And if you're 55 or older, you get a $1,000 catch-up on top of that $3,550 or $7,100, similar to the catch-ups you'll find in a retirement savings plan. Some employers make HSA contributions on their employees' behalf. If yours does, just know that whatever money you get counts toward these limits.
The tax benefits of HSAs
What makes HSAs so valuable is not just the flexibility they give you with using your funds, but also the tax breaks involved. First, the money you put into an HSA is tax-free, which means you immediately shield a portion of your earnings from the IRS. Imagine, for example, that you put $3,000 into an HSA this year and also fall into the 24% tax bracket. In doing so, you effectively save yourself $720.
Next, any money you don't withdraw for immediate healthcare expenses can be invested, and the gains in your account are yours to enjoy tax-free. Finally, HSA withdrawals are tax-free as well, provided that money is used for qualified healthcare expenses. All told, you get three distinct tax breaks rolled into a single account.
It pays to open an HSA
If you've been shying away from opening an HSA because you're not familiar with how these accounts work, it pays to read up on their benefits and rules. Funding an HSA is a great way to enjoy some lucrative tax savings, all while buying yourself the peace of mind that comes with knowing you have a means of paying your healthcare expenses -- both now and in the future.
