Updated January 31, 2023- When you think of savings accounts with a tax benefit, you likely think of retirement accounts such as 401(k)s, IRAs, Roth IRAs, etc. All of these types of accounts have great tax benefits and are appropriate in different situations. However, what if I told you that health savings accounts combine the best tax savings features of all of these accounts, enabling you to get triple the tax savings?

What is a health savings account (HSA)?

An HSA is a type of savings account that allows you to save money on a pre-tax basis to pay for qualified medical expenses.

Who is eligible to contribute to an HSA?

While the funds in an HSA can be used at any time for qualified medical expenses, contributions can be made only if you have a high-deductible health plan (HDHP). When you enroll in a health plan, through your employer or in the marketplace, you can see if the plan is “HSA eligible.” The maximum contributions for 2023 are $3,850 for self-only coverage and $7,750 for family coverage.

What are the tax benefits of using an HSA?

The health savings account is seen by many as the most tax efficient, allowing earned income not to be taxed because of triple tax savings. First, contributions to an HSA are made pre-tax, either by reducing your W2 wages or giving you a deduction on your tax return. If you make the contribution through an employer’s cafeteria plan, the contribution will also not be subject to payroll taxes. Second, the earnings in your HSA are not taxed, allowing the account to grow faster. Third, distributions from the account are not taxed if the funds are used for qualifying medical expenses.

What are qualifying medical expenses that an HSA can be used for?

Qualifying medical expenses include deductibles, copayments, coinsurance, prescriptions, etc. You can even pay for some Medicare expenses with an HSA, including Medicare Part B and Part D and Medicare Advantage plan premiums, deductibles, copays, and coinsurance.

How can I use an HSA in my overall financial plan?

Conventionally, contributions are made to your HSA and all medical expenses are paid out of the account as incurred. However, another way to take advantage of the long-term tax savings available with an HSA is to treat it like another retirement account, contribute the maximum amount each year, and wait until retirement to begin taking distributions. This requires having cash flow to cover medical expenses as incurred, but if needed, you can distribute money from the account at any time to reimburse yourself for prior medical expenses. If managed well, your HSA may be able to pay your Medicare premiums and medical expenses in retirement.

The mechanics of an HSA take some getting used to if you use the account like another retirement account. However, if it fits well in your overall financial plan, this highly tax-efficient savings account can be a very useful component in your retirement portfolio.

What can go wrong with an HSA?

While an HSA can be an important component to a financial plan, there are a few points to be mindful of so the HSA doesn't become a detriment. First, keeping up with an HSA can be difficult when using the account as additional retirement savings. To withdraw the funds tax-free in the future, one must have qualifying medical expenses and keep the support in case of an audit. Unless you have large qualifying medical expenses, maintaining support for numerous smaller expenses can become cumbersome.

Second, if an HSA is not spent down during the owner's life, it can potentially cause tax issues for heirs. When the owner of an HSA dies before the funds are exhausted, it becomes taxable to the heir. Depending on the situation, this can cause tax issues for the heir. Therefore, an HSA is not a good way to pass money to the next generation.

Despite these negatives, an HSA can still be an important part of your financial plan if managed correctly.

To learn more about how Health Savings Accounts may work in your financial plan, contact us.