Health Savings Accounts: not as foreboding as they seem

Consult a tax professional to see if you qualify for any of the deductions, exemptions or credits discussed in this article.

Despite the limited number of savings account variations, consumers can easily interpret an adjective like “health” in front of an offering as a warning to steer clear of a product with a web of fine print. The ever-evolving language surrounding health care plans and costs is not making that perception any easier to overcome. However, a Health Savings Account (HSA) could quickly become an essential part of your long-term financial strategy if you learn how you can use it to your advantage.

Lessening your tax burden 
The most advantageous characteristic of a Health Savings Account is its tax savings benefit. All contributions to the account – up to $3,300/year for an individual and up to $6,550/year for a family for 2014 – are tax-deductible, and thus can be deposited into your account on a pre-tax basis. Plus, if you’re 55 or older, you can make a “catch-up” contribution of an additional $1000 for 2014. Earnings (from principal growth) that accumulate are tax-free at the federal level and possibly at the state level (states vary as far as the tax status they give to HSA earnings). Contributions and earnings are tax-free. So are withdrawals as long as they are used only for qualifying medical expenses (a list of which can be found in IRS Publication #502). 

After the age of 65, you can withdraw funds from your HSA for any reason with no penalty, but any withdrawals not made for qualifying expenses must be reported as income on your tax returns.

Healthy and stealthy 
Essentially, HSAs help manage medical expenses (which are more or less inevitable) while encouraging accountholders to reduce healthcare costs when possible and seek out more prevention-minded solutions. Only those insured by high deductible health plans, as defined by the IRS, are eligible for a Health Savings Account. Thus, many individuals and families with high deductibles will use an HSA to cover the “first dollar costs” of medical coverage. The fewer of these “first dollar costs” they incur (i.e., the healthier they remain), the better opportunity their savings have to grow.

However, when medical costs do occur, some stealthy accountholders will elect to simply pay them using another type of account or cash. They do so because HSAs have no deadline for self-reimbursements when it comes to qualified medical expenses. HSA accountholders are allowed to save their receipts or bills for years before actually withdrawing the corresponding tax-free funds. Obviously, this strategy requires a bit of extra liquidity, but it can be a good way to take advantage of compounding interest while maintaining an easy withdrawal option.

Employer Contributions 
Some employers will offer to contribute a certain amount to your Health Savings Account each year as a part of your benefits or compensation package. If this is an opportunity for you, then you should seriously consider receiving the free money! HSAs can’t be rolled into an IRA or 401(k), but they will go with you if and when you leave the company, so every dime your employer contributes is yours to keep. Also, if you decide to end your high deductible insurance coverage while your HSA is open (perhaps because your employer is offering you a better plan), then you will no longer be able to contribute to the account, but the funds will still roll over year to year and may continue to increase in value via interest or principal growth.

Self-Managed Investing 
Many Health Savings Account offerings will allow the accountholder to actively manage how his or her contributed funds are invested. Alliant Credit Union currently offers a dividend rate of 0.65% (that is almost twice the national average for health savings accounts!) on its HSA offering and issues a debit card and free checks for easy access. However, if you would like to target a higher rate of return, Alliant also allows you to convert your HSA into an investment vehicle and build a customized portfolio based on your own choices.

Tax savings, medical expense management, employer contributions, and the ability to customize an investment portfolio are a few advantages of a Health Savings Account that could help you rack up some serious savings – at the very least, you should no longer fear it just because of its somewhat foreboding name.