Leveraging HSA Tax Benefits: The Triple Tax Advantage

There are savings to be found within Health Savings Accounts (HSAs). Too bad not many know about them.

In fact, 38% of HSA account holders have no idea the funds in the account can carry a triple tax benefit if used appropriately. While most people know about 401(k)s, and the average investor understands their deferrals may qualify for some tax advantages, most people don’t get how HSAs can work for them.

Similar to their older brother, the Flexible Spending Account (FSA), many individuals incorrectly assume the same “use it or lose it” feature applies to HSAs. In fact, two out of every five account holders still believe they will lose their balance if it is not spent by the end of the year. This misconception, along with a general lack of knowledge regarding their taxation, makes the HSA a valuable—yet stealthy—planning tool you may not be using.

So How Does the Triple Tax Advantage Work?

To start, money invested in the HSA is tax-deductible up to the annual IRS limit. 2018 contribution limits are $6,900 for families and $3,450 for individuals. You can invest funds in the account (more on that later) and the growth is tax-deferred. Here’s the kicker - prior to age 65, if you use the money for qualified medical expenses, the original contribution and any growth can be distributed tax-free! Boom…triple tax advantage! Compare that to your traditional 401(k) deferral, where distributions in retirement are fully taxable at your ordinary income rate.

To maximize the HSA opportunity, you’ll want to consider a few simple steps. First off, max out your contribution every year. HSA funds can be used for expenses like prescription drugs, copays, deductibles and even Medicare Premiums. Fidelity estimates the average couple, retiring at age 65, will have $280,000 in medical expenses in retirement. So, don’t be shy about maxing out that account!

What About After Age 65?

Here is where things get really interesting. After you turn 65, withdrawals you do not use for qualified medical expenses no longer face the 20 percent penalty. Meaning, once you turn 65, distributions from the HSA will be treated exactly the same as distributions from your 401(k) or IRA. This adds an additional layer of flexibility to the account. Sure, taxable distributions aren’t as attractive as tax-free, but at least you won’t be penalized if you use the money for something other than qualified medical expenses.

You will get the most “bang for your buck” by treating your HSA as a long-term savings vehicle and investing the funds. Remember, even the growth can be distributed tax free. While it is very tempting to use the account as a short-term savings vehicle for regular medical expenses, we recommend you do not dip into your balance if you can afford medical expenses today.

Most plans will require a minimum amount remain in cash, typically around $2,500. Once you meet that threshold and are confident you have enough cash (either in an emergency savings account or in your HSA) to cover anticipated medical expenses, invest the rest for long-term growth.

HSA providers have greatly expanded available investment options, allowing savers the ability to create a low-cost diversified portfolio for long-term growth.

As your employer benefits evolve, be cognizant of new and different avenues for saving long-term dollars. A CERTIFIED FINANCIAL PLANNER™ professional can help you navigate this complicated arena and recommend a strategy that is best for you and your family.