By John Drachman
Portability and tax breaks are just two of the pluses offered by Health Savings Accounts (HSAs). Created by Congress in 2003 to motivate individuals to save money for their future health care needs, HSAs also present some unusual drawbacks to health-conscious consumers.
The Advantages of HSAs
Many routine expenses qualify under the HSA rules as detailed in IRS Publication 502. Additionally, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed in 2020, added over-the-counter medications and more to the IRS list.
- Anyone can contribute: Similar to 529 plans, contributions can be made by you, your employer, or anyone else who wants to add to your HSA – as long as you stick to the limits. For 2021, the limit is $3,600 for individuals and $7,200 for families, plus an additional $1,000 “catch-up” contribution for anyone age 55 or older.
- Tax advantaged savings: Contributions to HSAs aren’t subject to federal income tax, and the earnings in the account grow tax-free. Also, withdrawals are not subject to federal (or in most cases, state) taxes if you use them for qualified medical expenses.
- Portability. Changing employers? No problem. The money in your HSA goes with you even if you change health insurance plans or retire.
The Downside of HSAs
HSAs are not for everyone. The reason: HSAs require you to be in a High-Deductible Health Plan (HDHP). This can be prohibitive if hefty medical bills are just around-the-corner.
- Savings psych-out: According to the Employee Benefit Research Institute (EBRI) which tracks HSA trends, some account holders refrain from spending on their medical needs because of their reported reluctance to draw down amounts from a savings account – even one for their health.
- Keep good records to avoid taxes and penalties: Withdrawing funds for non-qualified expenses before reaching age 65 can result in additional income taxes plus a 20% penalty. Prepare for potential IRS audits by keeping receipts to show your withdrawals were for qualified health expenses only.
- Fee creep: HSAs charge a range of monthly maintenance fees or per-transaction fees that can vary from provider to provider. Make sure you know what you are paying for.
The Bottom Line
If you are in good health and have an HDHP, an HSA can be a smart way to save for future medical expenses. “HSAs offer a valuable tax incentive to set aside money… for current or future medical expenses,” according to EBRI. “However, account owners often appear to be using the accounts primarily to cover current expenses… rather than contributing the maximum or maintaining HSA balances for health care expenses in retirement. Further, use of investments other than cash within HSAs remains low.” With HSA’s long-term value versus other savings or investment alternatives still in question after eight years, consider asking your financial advisor for an opinion before taking the HSA leap.
John Drachman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. John is an IABC award-winning writer, who applies his 30 years of financial marketing experience toward advancing the dialog between investors and investment professionals.
