Health Savings Accounts – Basics
HSAs are the only account that has the possibility of NEVER being taxed.
I’ve already talked a lot about health savings accounts. I’ve mentioned them in my posts about healthcare, but I’ve also brought them up as part of a comprehensive savings strategy. Now it’s time to go into some details on exactly what these accounts are, how they work, and how you can benefit from them. To summarize – they are the best place to put your investments if they’re available to you, the combine the tax-deferred benefits of a traditional IRA with the potential for tax-free withdrawals. HSAs are the only account that has the possibility of NEVER being taxed.
I’ll be pulling most of my information from our friendly neighbors the IRS their publication 969 – the document covering HSA and a number of other nifty savings vehicles.
First, let’s go over basic qualifications. What qualifications do you need to need in order to contribute to an HSA?
- You must be covered under a high-deductible health plan (HDHP)
- You have no other health coverage except
- You are not enrolled in Medicare
- You cannot be claimed as a dependent on someone else’s 2015 tax return
The last three are pretty simple, but number one can get a bit complicated. What’s meant by a ‘high-deductible health plan’? Fortunately, this is also pretty simple. Your health plan just has to meet a couple criteria:
Basically, your plan has to have a high deductible but not TOO high of a total out of pocket cost. As long as your plan falls within this range you qualify for an HSA. If you qualify for an HSA you can contribute up to $3350 as an individual or $6750 as a family.
How do you set up an HSA?
It’s easy! Often if you qualify for a plan through employer-provided insurance, your employer will also provide an HSA plan, sometimes with matching contributions. If you’re on your own the options are even more numerous. Vanguard offers a plan for individuals, and as with so many other things I would recommend them for an HSA as well.
How do HSA’s work? What are the benefits?
Also pretty simple. You contribute to an HSA and you can deduct those contributions from your taxes, both state and federal. In this way, they’re exactly the same as a normal 401k or IRA.
Once the money is actually in there are a couple things you can do:
- Treat them just like any other retirement contribution! You can simply leave any contributions in an HSA and never touch them. They then grow until your normal retirement age and at age 65 you can access them in almost exactly the same way you access a normal 401k or IRA – you pay normal income tax on the withdrawals. But meanwhile, you received a huge amount of tax-free growth over a number of years. In this way, an HSA simply acts as another retirement account above and beyond your IRA or 401k
- Use them for tax-free money at any time! You can withdraw money at any time for qualified medical expenses. Any withdraws for qualified medical expenses are completely TAX-FREE. This is huge! As it enables you to completely shield these contributions from tax. They’re tax-free going in, but also tax-free coming out.
Why HSA’s are awesome
The most beautiful thing about option #2 is there is no limit on when you actually have to claim the qualified medical costs. You can always pay the costs out of pocket and save the bills for a much later date, leaving all your money to grow tax-free. Then if you ever do need to withdraw from your HSA for ANY purpose, simply bring out those old bills and collect the tax-free distribution. As long as you keep careful records it enables you to bank up another source of tax and penalty free withdrawals for an early retirement.