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Thoughts on Health Savings Accounts (HSAs)

| April 12, 2018
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Health Savings Accounts (HSA) have been around for about ten years, but they are just now starting to gain mainstream attention.The main attraction to HSAs is the triple tax benefit they receive in the form of tax deductible or after-tax contributions, tax-exempt growth, and tax-exempt withdrawals for qualified medical expenses.  This is very hard to beat from a tax perspective and is why they are becoming more and more popular.

 In 2018, individuals can contribute as much as $3,450 for single coverage, or up to $6,850[1] for family coverage.  Unlike Flexible Savings Accounts, the year-end HSA balance can be rolled over annually which can allow you to potentially accumulate a sizeable amount that can be used in later years. According to Fidelity Investment, it is estimated that a 65-year old couple retiring in 2016 would need $260,000, or about $13,000 annually for 20-years, to cover health care related expenses.   As you can imagine, the ability to cover these expenses with tax-free income from an HSA would be very beneficial.

 With that said, it is important to not let the tax tail wag the healthcare dog, so to speak.  While the tax benefits are very appealing and there is the potential to accumulate a significant amount of assets that can be used to cover healthcare expenses in retirement, there are many factors to consider when contemplating if utilizing an HSA is right for you and your family. 

 The following are some factors I think you should consider:

 

  • What coverage is right for you? – the primary driver of the type of health plan you select each year should not be driven by the benefits of an HSA. To open an HSA, you must participate in a high-deductible health plan, so you need to determine if this type of plan provides the best coverage that fits you and your family’s needs. You need to consider costs of the plan such as total out-of-pocket maximums, deductibles, and co-pays, as well as some benefits such as any HSA seed money or employer contributions to your HSA. 

If you find the high deductible plan offers appropriate coverage at a comparable cost, then that will provide the opportunity to utilize an HSA and explore this strategy further. 

  •  Do you like taxes? – wouldn’t it be great to meet the guy or gal that would answer this with an emphatic, ‘YES’?! It’d be like seeing a unicorn. 

 Obviously, nobody likes to pay taxes.  The tax benefits of an HSA can benefit most anyone even if you’re taking out all your HSA contributions each year.  You’d still have tax-deductible contributions lowering taxable income and tax-free withdrawals for qualified medical expenses.

  • How’s your health? – being healthier, no matter what age, would most likely allow you to leave HSA assets untouched since you would not be incurring significant medical expenses. Of course, just like with retirement savings, the earlier you can start saving and accumulating funds in an HSA, the better.
  • How’s your bank roll? – a strategy often discussed to accumulate significant HSA assets for retirement assumes those individuals can afford to cover current health care expenses without tapping into their HSA. Now, I don’t know about you, but this is a pretty big assumption!

 Think about your monthly budget. Now, add a $5,000 medical bill. Are you able to meet that without charging it? How long will it take to pay that off? Will you incur interest? What about a $10,000 bill? At this point, are you pulling from your emergency fund? How long will it take to replenish that?

See where I’m going here?  This strategy really looks great when HSA funds are allowed to accumulate and grow undisturbed for a number of years. Unfortunately, life happens and people get hurt or get sick and can incur significant medical expenses. How many of us can cover these expenses out of pocket?  Well, I’m glad I asked.  A study by the Employee Benefits Research Institute found that 3% of those that enroll can pay their expenses out of pocket.

 So, really, we’re talking about wealthier individuals that have the means to cover medical expenses out-of-pocket.  Or, we could be talking about anyone with a strong cash flow due to low living expenses with a steady paycheck coming in and an adequate emergency fund.

 For the other 97% of us that can’t cover costs out of pocket on a regular basis, you may want to consider a more muted version. It may be beneficial to cover smaller, more manageable medical expenses out of pocket when you can so you are able to preserve your balance for future years or for those large, unforeseen medical expenses.

 My two cents?  The triple tax benefit of an HSA is really hard to beat and I believe there are real advantages in using an HSA when it’s right for the individual.  However, as I’ve pointed out, it’s just not as simple a decision as it is so often presented.  All aspects of your financial picture must be considered.

 It’s always best to have a plan.  Many financial advisors offer planning services that can provide a picture of your overall situation and will let you know if you’re on track to meeting your goals.

 

Alex Kowerko, CFP®, ChFC®, CLU®, FLMI®, FSRI® is not affiliated with LPL Financial, Cornerstone Wealth Management LLC, or RP Zeigler Investment Services, Inc.

 

[1] Withdrawals from a healthcare savings account (HSA) for non-qualified expenses are subject to income taxes, and if made prior to age 65, a 20% penalty may apply.  

 

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