A Health Savings Account (HSA) is a triple threat. Its contributions, earnings and withdrawals are (mostly) tax free. Money rolls over year to year (unlike the much inferior FSA – flexible spending account), the HSA is yours to keep forever- even if you quit your job or lose your health insurance, and you have flexibility in how you use the money in the account. Now getting your triple-tax advantaged enterprise operational will take a little bit of leg work, but it’s worth it. Many Citizens of Moneyland have done it before you, and so can you. Let’s see how it’s done.
How do I get an HSA?
First, to be eligible for an HSA, you must be enrolled in a high deductible health plan (HDHP). As you can probably guess, HDHPs have low premiums but high deductibles. For 2020, out of pocket deductibles can range from $1,400 to $6,900 per year for individuals and $2,800 to $13,800 per year for families. As you can imagine, if you have chronic medical problems or have any large medical expenses planned, a HDHP might not make sense for you. You should seriously consider if these health plans are right for you prior to enrolling.
Next, you enroll in a HDHP through your employer or the healthcare exchange. Your employer should clearly delineate which health plans are HDHPs eligible for HSAs and which are not. If they do not, ask them. Some employers may also not offer HDHPs, and if so, no HSA for you . 🙁
After enrollment, your health insurance company should provide details on how to open your HSA debit/checking account, the first piece of your HSA enterprise.
Next, you determine how much you want to contribute to your HSA debit/checking account, usually through your employer. These contributions are tax-free! Dollars that would have been going to the tax man are now yours forever! This is basically like giving yourself a raise, so do it – you deserve it. But of course there is a limit to how many dollars you can squirrel away into this majestic beast of an enterprise – in 2020, the max yearly contributions are $3,550 for self-only account and $7,100 for a family account.
Once you’ve opened your HSA debit/checking account, the ‘HSA bank’ will send you a debit card and should set you up with an online account. Money will enter this account from deductions from your paycheck.
Now for part two of the triple-tax advantage – the HSA investment account. At this point, you should have regularly scheduled pre-tax contributions coming into your HSA debit/checking account. But, that money is getting a measly 1% interest if you’re lucky… which is garbage.
Now, the HSA investment account is where the magic happens. To set this up, you usually just need to look around online on your HSA debit/checking account (I know, I know… they don’t make this easy).
Usually your HSA investment account will require yet another online HSA account, typically held at a brokerage firm – like TD Ameritrade.
Once you have the HSA investment account open, you’re in business! Best thing to do now is set up recurring transfers from your HSA debit/checking account into your HSA investment account to get that puppy funded. Once you got cash in the HSA investment account you can now buy securities – usually a pretty decent selection with stocks, bonds, mutual funds and/or ETFs – the preferred investment vehicle here in Moneyland.
Now guess what? Your money is now growing at a much greater rate than that measly HSA debit/checking account. AND, once you sell off those securities ALL OF THE CAPITAL GAINS are TAX FREE. That’s right. Tax free capital gains.
But how do I get my money?
Yes, all this is nice and all, but how do I get my money? Well HSAs are (somewhat) flexible in how you make this happen.
You have two main options. You can either – use the HSA to pay for qualified medical expenses (as it is intended for) –OR- treat the HSA like a retirement account.
If you decide to treat the HSA like a retirement account and you don’t deduct any of your money until you’re 65 or older, then you just pay your regular ordinary income tax rate at that time. In other words, you treat your deductions like income. Which is the same as traditional IRA accounts, but not as wonderful as roth IRA accounts. Using your HSA this way is not quite a triple-tax free advantage, but pretty close as you didn’t pay any tax on the contributions nor the capital gains.
If you decide to use your HSA funds for qualified medical expenses, swipe that HSA bank debit card for those expenses, keep your receipts as proof for the tax man, and enjoy paying $0 in taxes. You’ve taken full tax advantage of the HSA triple-threat. You can also use your regular credit card or checking account and reimburse yourself from your HSA debit/checking account. What are qualified medical expenses? The IRS has your answer right here.
Also, a few little interesting loopholes – you can use your HSA to pay for healthcare expenses for your spouse and/or your dependents from YOUR account AND you can take money out to cover healthcare expenses incurred from anytime after the HSA was opened.
For example, if you opened your HSA in 2010, broke your foot in 2012 and paid out of pocket healthcare expenses at that time with non HSA money and kept the receipts, you can then “pay yourself back” in 2020 and withdraw the money from your HSA if you’d like. Now, the accounting for all that gets a little confusing, so I advise to keep it simple and just pay healthcare expenses as you go.
HSA: What NOT to do
There are a few things you should definitely NOT do with an HSA —
- Enroll in a HDHP just for the HSA. Everyone’s healthcare needs are different. Given that healthcare costs with a HDHP are likely going to be higher if you have ongoing medical expenses, the advantages of an HSA just might not make sense. Further, the triple-tax advantage of HSAs only really magnify over longer time horizons – 10-20 years or more. Put your health first. Otherwise you or your family may never see these monetary benefits.
- Withdrawal money for non-healthcare related expenses before the age of 65. Don’t do this. Ever. Not only will you have to pay ordinary income taxes on the money you take out, but also a 20% penalty on top of that. Ouch!
- Forget to keep your receipts. This would be a major bummer if the tax man ever decides to give you an audit. Please, please keep your receipts and stay organized.
- Not set up an HSA investment account. Without an investment account, you’re missing out on an essential part of the tax advantage – the tax free capital gains! Unfortunately, you will have to set this up yourself… because why should they make it easy for you?
- Invest in risky investments or those with high costs. Like any other investment account, you have to be careful as to how you invest. You can lose all your money (although unlikely) or, worse, invest in high cost vehicles that insidiously eat away your earnings.
Realized Citizens of Moneyland will have maxed out their HSA year over year, invest their money thoughtfully, and use their account in the most tax-advantaged manner possible.
Your fearless leader, forever in your debt,
Agree with your leader? Have thoughts on the HSA account or other tips to share? Comment below