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Advantages of a Health Savings Account (HSA)

Advantages of a Health Savings Account (HSA)There are many advantages of having a Health Savings Account (HSA). An HSA is a tax-free savings account that can be used for medical related expenses. There are some rules around an HSA that makes it very advantageous for saving money and saving on your taxes. Let’s look at the advantages of a Health Savings Account.

Three advantages of a Health Savings Account include saving on your taxes. Money put into a Health Savings Account is tax free when you save the money, it grows tax-free, and it’s tax free when you spend it on qualified medical expenses. When you add up these tax advantages, an HSA is like a Roth IRA on steroids.

In order to qualify for a Health Savings Account, you must have a high-deductible health plan. Unlike a Flex Spending Account, the money in your HSA carries over from year to year.

Savings is Tax Free

The money you put into your HSA is tax free–it’s an above-the-line deduction. Above-the-line deductions are deductions before you itemize or take your standard deduction. That means that anyone who saves money in an HSA does not pay tax on this money. It’s like a traditional IRA in this regard.

There are limits to how much you can save a year, so always make sure you know what that limit is. In 2020, the limit is $3,550 for a single person, and $7,100 for a married couple. There is also a $1,000 catch up contribution limit for anyone over age 55.

Money Grows Tax Free

The money in an HSA grows tax free. This money growing tax free is the same as an IRA. Depending on your HSA plan, you can invest your money in almost anything you want.

Tax Free Distributions

When you use the money for qualified medical expenses, you pay no tax on the money. This is also the same as a Roth IRA except that the expenses need to be qualified medical expenses.

The caveat that this money needs to be spent on qualified medical expenses really isn’t that big a deal. Who won’t have medical expenses? On average, people will spend $122,000 in medical expenses after they retire.

Can Be Used for Anything at Age 65

When you are 65, you can withdraw the money just as you would money from a traditional IRA. This means that you can withdraw the money, pay ordinary income tax on it as you would a traditional IRA, and then spend the money on anything you need to spend it on. If you spend it on qualified medical expenses, it’s always tax free, but you can also spend it on anything you need to after you turn 65. Money in a traditional IRA can be spent after age 59 and a half with no penalty, so there is one slight disadvantage of having it in an HSA as opposed to a traditional IRA.

HSA vs Emergency Fund

Should you save money in your emergency fund or in an HSA account? It depends on which baby step you are on.

If you are on baby steps 1, 2, or 3, don’t worry about saving money in your HSA. Concentrate on saving your $1000, paying off your debt, and saving an emergency fund. That doesn’t mean you shouldn’t have an HSA if you have a high-deductible health plan. In fact, you should have an HSA opened, and all your medical expenses should go through it to save on taxes. There is no reason that you should pay tax on any of that money that qualifies for a tax savings. There are two ways that you can save money on your qualified medical expenses without constantly saving money in your HSA.

When you know you’re going to have a qualified medical expense, you budget for it and set that money aside. This is how you budget as you would anything else. When it comes time to pay for that medical expense, you can move money into your HSA, and then spend the money from your HSA to pay for the medical expense.

You can pay for your medical expense and then move money into your HSA and then reimburse yourself from your HSA. This isn’t any more complicated, but it does require you to have twice the amount of money on hand to pay for your expense.

Don’t save money into your HSA when you are on steps 1, 2, or 3. When you have a qualified medical expense, you can move money into your HSA to pay for it. This is the easiest way to handle medical expenses.

What about when you are on baby steps 4, 5, 6, or 7? Once your house is paid off, you can use your HSA as an additional vehicle for saving for retirement. You can also use your HSA if you need another option to save 15% of your income for step 4. During these steps, if you have a constant medical expense, you can save directly into your HSA. Either way is ok.

 

If you have a high-deductible health plan, you should have a Health Savings Account. You get the triple tax advantage, and it can also be used as another avenue for retirement saving.

 

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5 Comments

  1. I disagree with not funding the HSA during steps 1-3 if you have known expenses every month. Putting at least that into the HSA pretax (since that’s one of the benefits) will save you money on something you’ll already be spending money on. If I have $25/month in long-term prescriptions, I know I’ll have at least $300 a year to spend. If I divert $25 pretax to the HSA, I have it available to spend for my prescriptions each month and save money doing it. I do agree not to fully fund it while in 1-3 (need the money for the priorities) but it seems short-sighted to spend more than you have to on known must-have expenses that qualify.

    • Thanks for the comment. It looks like we are in agreement. “When you have a qualified medical expense, you can move money into your HSA to pay for it.” In your situation, you have a known monthly qualified expense. When it’s time to fill your prescription, move money into your HSA. Since it’s a monthly expense, you can automat that transfer if you want. Just don’t build up your HSA “just in case” if you have dent to pay off.

      • But if you move it into your HSA, you’re using AFTER tax funds vs. the pre-tax funds. If you know it’s coming up (ex: someone has meds for hypertension or insulin), you won’t suddenly not need it later in the year. If you have the money taken pre-tax, you’ll at least save that money on the tax. You won’t need to earn as much in order to take care of it. Agree to disagree, I guess.

        • You maybe are referring to having an employer sponsored HSA, but it works the same way tax-wise when it comes to federal income tax savings if you don’t have an employer sponsored HSA.

          All money you put into your HSA (up to the limit) is pre-tax. Money put into an HSA is an above-the-line deduction. You can even add money to your HSA for a tax year up to April 15 of the following year (when you file your taxes). It’s all tax deductible. If you want the additional take home pay throughout the year, adjust your W-2 accordingly.

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