Health Savings Accounts Offer a Tax Break for High-Earners
When used correctly, HSAs can be the ultimate tax savings strategy.| By: Randall E. White, CFP®, RICP®, CRPC®, CMFC®
Protecting as much of your earnings as possible is key to wealth building, making it imperative for high-earners to develop a savvy tax strategy. Health Savings Accounts (HSAs) are often a viable option, though they tend to be overlooked or misunderstood. When they’re used correctly, however, they can be a fantastic tool to have in your financial planning toolbox. An HSA cannot only provide an easy annual income tax deduction, but it can also create a dedicated, tax-free vessel of funds on hand to cover any healthcare costs you may encounter during retirement.
How do HSAs Work?
A Health Savings Account (HSA) is a federally tax-exempt savings account that lets you put aside money on a pre-tax basis to pay certain qualified medical expenses. An HSA typically starts as a cash account that earns interest, but once it reaches the threshold balance it can then utilized as an investment account. One of the benefits of an HSA is that, even without submitting itemized tax returns, eligible individuals can contribute to the account annually and receive an immediate tax deduction.
An HSA provides a tax-deduction upfront on contributions, tax-free growth within the account, and tax-free distributions, making the HSA the only triple-tax-free savings account option available. Currently, these benefits are available for up to $3,600 for individuals or $7,200 for families, along with a $1,000 catch-up contribution.
HSA vs FSA: What’s the Difference?
Though both Health Savings Accounts and Flexible Spending Accounts (FSAs) can be beneficial for your savings strategy and for managing your medical costs, you’ll usually be forced to choose between them because you cannot have both at once. The exception to this rule is if you qualify for an HSA and your FSA is a “limited purpose” FSA, which you can learn through your employer’s human resources representative. Limited purpose FSAs can only be used for dental and vision care expenses.
So, most people are left with a choice to make. Thankfully, FSAs and HSAs have distinct characteristics that make the choice fairly easy depending on your situation. FSAs require the funds you’ve saved to be spent each year, otherwise, they are forfeited. Additionally, funds in an FSA are not permitted to be invested. Conversely, with an HSA you can invest the money in your account and you’re actually incentivized to keep funds in the account for the long-term, so you’re not forced to empty the account each year.
Qualifying for an HSA
Many people take advantage of an HSA offered through their employer, but you can open an HSA with a private insurance plan, too. However, you cannot make current-year contributions unless that insurance plan is an HDHP. An HDHP is a high deductible health plan. These plans are quite common, and the IRS has rules about which ones qualify for an HSA. Generally speaking, you’ll need to have a deductible of at least $1,400 for a single person or $2,800 for a family.
Some additional requirements include an age requirement of 18 or older. If you’re enrolled in Medicare, you can still use an existing HSA, though you will not be permitted to contribute to it. You also can’t qualify if you can be claimed as a dependent on someone else’s tax return.
How to Make Money with an HSA
In order to take full advantage of one of the biggest benefits provided by the HSA – tax-free distributions – you’ll need to have qualified medical expenses. For most people, this won’t be an issue. Qualified medical expenses could include: a variety of out-of-pocket expenses, co-pays, deductibles, prescription drug costs, surgeries, and more. If you don’t have any current medical expenses, you may want to consider using your funds to cover past medical expenses if you have any outstanding. You can also use your HSA funds to pay for long-term care insurance.
SEE ALSO: Your Retirement Tax Prep List
If you don’t use your HSA funds on qualified medical expenses, you can wait and take the money out of your account after the age of 65 and pay the associated income tax. Though paying the tax isn’t ideal, the taxation works just like a traditional IRA and you’ll have at least potentially enjoyed years of tax-deferred growth.
Final Thoughts: Is an HSA Worth It?
For most people, electing to use an HSA is a savvy financial move, but this is even more so for high-income earners. Because these accounts allow you to claim a tax deduction, you get an immediate benefit when you contribute. Most HSA owners contribute each year and immediately turn around and spend the funds on healthcare costs. However, one of the key benefits of an HSA is the opportunity it provides you to generate tax-free investment growth, and this growth increases over time. If you’re able to wait to spend the money in your account, covering out-of-pocket healthcare costs before retirement by using money in your checking or savings, you’ll be able to invest your HSA funds for the long run. Doing so will allow you to retire with a dedicated account specifically set aside to cover healthcare costs throughout your retirement – and you’ll owe nothing in taxes.
Ultimately, if you’re a high-income earner, you can benefit the most from an HSA when you open an account, max out your annual contributions – enjoying the immediate tax deductions – and then let the investment account grow.
As always, when making any decisions that could impact your taxes, it’s wise to consult with a professional tax advisor. Tax laws change regularly, and every investor’s situation is unique, so it’s important to have experts in your corner to help you make wise and disciplined decisions toward reaching your financial goals.
At TriCapital, we offer comprehensive wealth management services, including tax planning and coordination. Contact us today to schedule a complimentary discovery call to see whether we may be the right fit for your unique needs.
Securities offered through Triad Advisors, LLC, member FINRA/SPIC. Advisory services offered through TriCapital Wealth Management, Inc. TriCapital Wealth Management, Inc. is not affiliated with Triad Advisors, LLC.