If the number of HSA benefits alone doesn’t convince you to open a health savings account, hopefully this article will change your mind. Let’s face it, we all go to the doctor and pay medical bills. Whether it’s for a preventative checkup or because of an unexpected medical emergency, we are all bound to have lots of medical expenses in our lifetimes.
Most of all, the average couple retiring at age 65 will spend $280,000 on health care costs alone during retirement1. It’s for this reason that you need to start saving now for your future health. There’s no better way to set aside money for inevitable medical costs than a health savings account.
What Is an HSA?
A Health Savings Account (HSA) is a savings account available to taxpayers in the United States who are enrolled in a high deductible health plan (HDHP). You can think of an HSA as a bank account dedicated to medical expenses. In fact, an HSA is actually a bank account—you will have an account number, debit card, and checkbook. The only difference is that you can only use your HSA to pay for qualified medical expenses.
HSA benefits are numerous. From the triple tax advantages of HSAs to the ability to use an HSA as a retirement savings vehicle, health savings accounts are truly the latest and greatest way to get the biggest bang for your buck when it comes to medical expenses.
HSA Triple Tax Advantage
There are many HSA benefits, but most noteworthy might be the tax advantages of having an HSA. A Health Savings Account is triple tax advantaged, meaning that it has three tax-related benefits.
- Pre-tax contributions: Money is contributed to your HSA before taxes are taken out of your paycheck. Therefore, your income is reduced and you pay less taxes.
- Tax-free earnings: Similar to a 401k and IRA, Health Savings Accounts are investible. Any interest or gains accrued is tax-free, so you don’t pay tax on your earnings.
- Tax-free withdrawals: When it’s time to pay for a qualified medical expense, you pay no tax on the money you withdrawal from your HSA account.
As a result, each and every dollar in an HSA account survives untaxed. This is truly radical and even outshines the Roth IRA in terms of tax advantages.
To demonstrate the tax benefits of an HSA, let’s compare someone with an HSA to someone without an HSA.
Significant HSA Tax Breaks
|With HSA||Without HSA|
|Left over||$27,375 + $500 HSA||$27,000|
|Income taxes (25%)||$9,125||$10,000|
As you can see, having an HSA results in hundreds of dollars of savings because of its tax advantages. Not only does the person with an HSA pay $875 less in taxes, but he also pays for his medical bills from his tax-free HSA account. In this case, the person with an HSA has 10% more money left over thanks to HSA tax breaks.
Use Your HSA to Save for Retirement
Prior to age 65, you will be charged a 20% penalty in addition to taxes for using your HSA for non-qualified medical expenses. However, this penalty is lifted after the age of 65. At 65, you can use your HSA for any non-medical expense and only pay income tax on distributions.
In this way, an HSA acts like a traditional IRA in retirement. This is why so many people use an HSA as a retirement savings vehicle. Starting at age 25, if you contribute $3,500 every year to your HSA and invest it with a typical 7% rate of return, you’d end up with a cool $750,000 in your HSA account at the age of 65. This assumes that the HSA contribution limit does not change from year to year (which is does) and that you don’t withdrawal any funds from your HSA during that time.
How Much Can I Contribute to My HSA in 2018?
For 2018, individuals can contribute up to $3,450. Families can contribute up to $6,900. For 2019, individuals can contribute up to $3,500. Families can contribute up to $7,000.
What Are Qualified Medical Expenses for HSA?
HSA money can only be used for qualified medical expenses. Qualified medical expenses include any expense that you incur at the doctor or dentist. A bill from your medical doctor or dentist is considered a medical expense. This includes your co-pays and deductibles.
The Internal Revenue Service’s Publication 969 is a 22 page document that explains HSAs and other tax-favored health plans. Publication 969 references Publication 502 for a detailed explanation of what qualifies as medical expenses.
Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners.
They include the costs of equipment, supplies, and diagnostic devices needed for these purposes. Medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They don’t include expenses that are merely beneficial to general health, such as vitamins or a vacation.
Medical expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract.2
Anything that your doctor prescribes to you is a qualified medical expense. If your doctor gives you a prescription for a deep tissue massage, then this is a qualified medical expense. If your doctor recommends acupuncture, but does not give you a prescription, then this is not a qualified medical expense.
Can I Use My HSA for Toothpaste?
Some might argue that toothpaste should be a qualified medical expense because it’s a cost to prevent disease. But unless it’s prescription toothpaste, it’s not a qualified medical expense. Basically, the cost of ordinary items, unless prescribed, are not qualified medical expenses.
Can I Use My HSA for Over-the-Counter Medication?
You can only use your HSA to buy over-the-counter drugs prescribed by your doctor. So unless you have a prescription for cough medicine or pain relievers, these expenses are not qualified medical expenses. Nutritional supplements are also not qualified medical expenses unless prescribed for a diagnosed medical condition.
Can I Use My HSA for Gym Membership?
You cannot use your HSA to pay for your gym membership, health club, or spa. You can, however, use your HSA to pay for membership in a weight reduction group for treatment of a specific disease diagnosed by a physician. This can include diseases such as obesity, hypertension, or heart disease. While gym membership fees are explicitly not qualified medical expenses, separate gym fees for weight loss classes can be qualified medical expenses.
As you can see, medical expenses are wide ranging, but not all inclusive and have restrictions. As Publication 502 points out, you cannot use your HSA to pay for your vacation even if your doctor recommends it. Always refer to Publication 502 when in doubt about what is a qualified medical expense for an HSA.
How to Qualify for HSA
Only those enrolled in a high deductible health plan can contribute to an HSA. The IRS defines a high deductible health plan as any health insurance plan with a deductible of at least $1,350 for an individual or $2,700 for a family.
Aside from the restriction that you must have a high deductible health plan, there aren’t too many other restrictions to qualifying for an HSA. Unlike the income restrictions for Roth IRAs, anyone with any income can contribute to an HSA. Even the unemployed and contribute to an HSA.
What Happens to My HSA If I No Longer Have a HDHP?
Don’t worry if you previously had an HSA with a high deductible health plan but are no longer enrolled in a HDHP. You can still use your HSA funds to pay for qualifying medical expenses—you just can’t contribute any more money to it.
Any money that you contribute to an HSA is always yours, even if you switch employers or change health insurance plans. This includes interest that you earn from investing your HSA funds.
Should You Get an HSA?
Don’t like paying tax? Neither do I, and that’s why I max out my HSA contributions every year. Is an HSA worth it? You better believe it is.
Once you realize how HSA tax benefits save you money on your medical expenses, you will hopefully take action and open your own HSA account. Anytime you pay for a medical expense with non-HSA money, you are paying more than you have to. Even if you are healthy as a horse today, start saving tax-free money to pay for your medical expenses when you are not as fortunate.
If eligible, I highly encourage all of you to open your own HSA today. Even if you don’t contribute the maximum amount, you will be doing your future self a huge favor.