Health Savings Accounts: A Simple Tax Break for High Earners

Time to Read: 5 Minutes

The number of tax-savings strategies available to affluent investors and high-income earners continues to shrink—but Health Savings Accounts (HSAs) are a noteworthy exception to this trend. Often overlooked or misunderstood, HSAs can be a great tool when used correctly. An HSA can create an easy annual income tax deduction and a dedicated, tax-free bucket of funds to cover healthcare costs during retirement.

How do HSAs work?

An HSA is a federally tax-exempt account designed to pay for certain healthcare costs. Eligible individuals can contribute annually to an HSA and receive an immediate tax deduction, even without submitting itemized tax returns. An HSA usually starts as a cash account that earns interest; once it reaches a threshold balance, it can become an investment account. Any investment gains earned in an HSA are tax free, and money withdrawn from an HSA to pay for eligible medical expenses is also tax exempt.

Is an HSA the same as an FSA? 

HSAs are not the same as Flexible Spending Accounts (FSAs). Although it’s easy to confuse the two, they have distinct characteristics. FSAs require funds to be spent each year, or they are forfeited. Funds in an FSA are not allowed to be invested. On the other hand, money in your HSA can be invested and you’re actually incentivized—not punished—to keep funds in the account for the long term.

At Stratos Private Wealth, we help our clients choose appropriate investments for their HSAs. We also link your HSA to your holistic financial plan so that we can review everything together during our regular meetings.

How do you qualify for an HSA?

Not everyone qualifies for an HSA, but many people can.* Many San Diego companies where our clients work are adopting HSA-compatible healthcare plans. The most common qualification criteria include:

• Coverage under a high deductible health plan – These plans are quite common and the IRS has rules about which plans qualify for an HSA. In general, you’ll need to have a deductible of at least $1,400 for a single person or $2,800 for a family.
• Not enrolled in Medicare – If you’re enrolled in Medicare, you can still use an existing HSA, but you cannot contribute to it.
• Other considerations – You must be at least 18 years old and you cannot be claimed as a dependent on someone else’s tax return. Check with your tax advisor for additional details.

Can I open a Health Savings Account on my own? How much can I save in an HSA in 2020?

Although many employers provide HSAs, you do not need to have an HSA through your employer. If you meet the eligibility requirements, you can open an HSA on your own. In 2020, the contribution limit for a single person is $3,550 or $7,100 for a family. If you’re over age 55, you can contribute an additional $1,000 per year. Although these contribution amounts may not seem large, annual contributions can add up. For example, a 45-year-old person saving into a family plan could have an HSA valued at more than $200,000 before qualifying for Medicare at age 65.

What’s the catch?  How do I take money out of an HSA?

In order to take tax-free distributions from your HSA, you’ll need to have qualified medical expenses. Most people won’t have difficulty with this. For those who do, we have some ideas. First, qualified expenses include a variety of out-of-pocket expenses, co-pays, deductibles, prescription drug costs and more. If you find yourself without qualified medical costs, consider using past medical expenses which would qualify for tax-free distributions—for example, that big medical expense from 12 years ago might qualify. HSA funds can even be used to pay for long-term care insurance. If all else fails, you can simply take the money out of the HSA after age 65 and pay the associated income tax. In this case, the taxation works just like a traditional IRA, which isn’t bad at all.

Is a Health Savings Account worth it?

Yes! Although this article only refers to Federal tax benefits, most states also offer favorable tax treatment for HSA accounts.  California and New Jersey have unique tax rules you should consider with your CPA or tax advisor.  However, we find that many of our California clients, for example, still benefit from HSA’s.  Let’s talk about our favorite strategy for using HSAs. Because these accounts allow you to claim a tax deduction, you get an immediate benefit for contributing. Most HSA owners stop there and overlook the additional benefits: They contribute each year and immediately spend the funds on eligible healthcare costs. The other key benefit of an HSA is the opportunity to generate tax-free investment growth. The value of this tax-free growth increases over time. Because the IRS doesn’t require account owners to take distributions in any set timeframe, investors can wait years to use their HSA funds for qualified expenses. As a result, we advise clients to invest their HSA funds for the long run. When medical expenses are incurred before retirement, we recommend resisting the urge to tap into your HSA.

Many clients of Stratos Private Wealth with HSAs are able to cover out-of-pocket healthcare costs before retirement by using money in their checking or savings accounts. Do this and you’ll retire with a dedicated account specifically set aside to cover healthcare costs in retirement. During retirement, use the HSA funds to pay for anything that qualifies—and pay nothing in taxes. We strongly believe this is a great strategy for people who qualify for an HSA. In sum, our clients benefit the most when they open an account, max out their annual contributions and enjoy the immediate tax deductions each year—then let the investment account grow and ultimately enjoy a dedicated tax-free bucket of money in retirement to cover qualified healthcare expenses.