Health Savings Accounts: Weighing the Perks and Fiscal Benefits

Health Saving Accounts (HSAs) offer numerous perks and fiscal advantages:

A Health Savings Account (HSA) is a tax-favored investment account accessible solely to individuals enrolled in high-deductible health plans (HDHPs). HSAs permit individuals to save tax-free for eligible healthcare expenditures and can double as retirement saving instruments.

If you qualify to contribute to an HSA, there are numerous reasons to consider doing so due to HSAs' extensive tax advantages.

To determine if contributing to an HSA is suitable for you, consider the generous benefits this type of account offers.

Tax advantages of Health Savings Accounts (HSA)

The tax advantages of an HSA are the most significant benefit of this type of account.

Various types of investment accounts, such as 401(k)s and individual retirement accounts (IRAs), offer at least some tax savings. You can contribute to traditional 401(k)s and IRAs using pre-tax dollars, and withdrawals from Roth 401(k)s and Roth IRAs are tax-free.

401(k)s and IRAs provide tax savings either at the time of contribution or withdrawal; however, HSAs differ in that:

Contributions to HSAs are made with pre-tax dollars. HSA contributions are deducted from your taxable income, often directly by your employer, lowering your tax bill. The tax savings equal the contribution amount multiplied by your marginal tax rate.
Funds in HSAs grow tax-free. Just like all 401(k) and IRA accounts, the funds accumulated in HSAs are tax-deferred. Depending on how you use the funds, the money may only be taxed upon withdrawal during retirement, when your tax rate may be lower than it is now. Capital gains earned in your HSA today do not affect your tax liability for the current year.
Withdrawals from HSAs are tax-free. You can withdraw funds from HSAs without incurring any taxes, as long as the money is used for qualifying medical expenses. This includes physical therapy, orthodontics, insulin, feminine hygiene products, prescription and over-the-counter drugs, and telehealth services. The amount of money you save in taxes equals the HSA funds withdrawn multiplied by your marginal tax rate.

Using funds from an HSA can provide a triple tax benefit, setting HSAs apart from all other investment accounts, especially if you incur significant medical expenses.

Seven additional HSA benefits

While the tax savings alone provide a good reason to invest in an HSA, this type of investment account also offers other benefits:

Regardless of income, you can contribute to an HSA. While some high-earners cannot contribute to Roth IRAs or make tax-deductible contributions to traditional IRAs, you can qualify for an HSA regardless of your income.
HSA funds can be withdrawn at any time to pay for qualifying medical expenses. While HSAs are excellent retirement savings vehicles, they're intended to help offset medical care costs by enabling you to withdraw funds when faced with qualified medical expenses.
HSAs do not expire, unlike FSAs. With an HSA, you do not need to withdraw funds in the same year. HSA funds may be invested at any time.
Seniors 65 and older can withdraw HSA money penalty-free for any purpose. Once you turn 65, you can withdraw money from your HSA for non-medical purposes without paying a penalty; you only owe taxes on the withdrawal at your ordinary income tax rate. This flexibility makes HSAs ideal for retirement savings.
HSAs do not have required minimum distributions (RMDs). Most tax-advantaged retirement accounts, including 401(k)s and traditional IRAs, are subject to RMDs, which mandate the withdrawal of a minimum amount of money each year. Those aged 72 or older must withdraw a minimum amount annually to avoid a 50% penalty on the amount that should have been withdrawn. With HSAs, you can leave your money invested for as long as you like.
HSAs can be opened in multiple ways and offer numerous investment options. Your employer may offer an HSA, but if you are eligible, you can also open one on your own with a bank or brokerage firm. You can invest your HSA funds in a wide range of securities, including mutual funds, ETFs, stocks, and bonds.
Your employer may also contribute to your HSA account. Assuming your employer offers HSAs, the company can directly contribute to yours. Contributions like these may be structured as matching programs.

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Maximizing the benefits of your Health Savings Account requires familiarizing yourself with its regulations.**According to data from Fidelity Investments, a retirement-age couple who turns 65 in 2020 and has substantial prescription drug expenses may need approximately $325,000 to have a 90% likelihood of meeting all their medical expenditures in the remainder of their life. Paying Medicare premiums, purchasing medications, and encountering other non-covered medical expenses are common and can be financially burdensome during retirement. Allocating funds to HSA investments can assist future retirees in setting aside money for an unanticipated healthcare cost.

Although HSAs aren't without drawbacks, including limitations on eligibility, potential fees, and a 20% penalty imposed on withdrawals not utilized for medical expenses, the advantages of HSAs generally surpass the disadvantages for most individuals.

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The tax advantages of an HSA make it an attractive investment option, as contributions are made with pre-tax dollars, funds grow tax-free, and withdrawals for eligible medical expenses are also tax-free. Additionally, HSAs can serve as retirement saving instruments, providing flexibility for seniors 65 and older to withdraw funds penalty-free for any purpose.

If you qualify to contribute to an HSA, considering its extensive tax advantages and other benefits, such as the ability to withdraw funds at any time and avoid required minimum distributions, can help you save money for future healthcare expenses, including potentially burdensome prescription drug expenses during retirement.