Written by: Pete Winnett, CFP®
Are your considering health insurance plans offered by your employer for 2022? Are you wondering if a High Deductible Health Plan (HDHP) combined with a Health Savings Account (HSA) might be a good idea for you and your family?
The answer will depend on your individual circumstances, however, HSAs can be a powerful way to lower your health care costs, reduce taxable income and build wealth. My clients have often heard me refer to HSAs as ‘IRAs on steroids.’
Potential benefits of an HSA include:
- HSA contributions reduce taxable income on the amount contributed each year up to Internal Revenue Service (IRS) prescribed limits. This reduced taxation will result whether an HSA is funded with pre-tax dollars from your pay and/or by being an “above-the-line” tax deduction on your tax return.
- HSAs reward those who maintain good health and have relatively low health care costs. The health insurance premiums saved with an HDHP can be used to help fund the HSA. To the extent those funds are not used the money is saved for future needs. There is no stipulation as to when the funds must be to be spent like there is with a Medical Savings Account (MSA). Money not used to cover out-of-pocket expenses such as health costs not covered by health, dental and vision insurance accumulate and grow tax-free for future use.
- Distributions for qualified medical expenses, as defined by the IRS, are tax-free, similar to distributions from a Roth IRA. Money withdrawn from the HSA for other than qualified medical costs will be subject to income taxation, like a traditional IRA, and will be subject to an additional 20% penalty if distributed prior to age 65.
- Accumulated funds can also be used to pay Medicare premiums. However, HSA funds cannot be used to pay for Medigap premiums.
- Because the employer also saves on their portion of the health insurance premiums, many employers contribute some amount to their employees’ HSAs as an incentive to enroll in an HDHP.
To qualify to contribute to an HSA you must be enrolled in a designated HDHP that has a minimum annual deductible and maximum annual out-of-pocket costs. For 2022 these are as follows:
Individual coverage Married or Family coverage
Minimum Deductible $1,400 $ 2,800
Out-of-Pocket Maximum $7,050 $14,100
Your health insurance plan and your HSA are totally separate. Your employer may direct employer contributions and/or your HSA payroll deductions to an HSA with a provider they have selected; however, you can choose from any of a growing number of HSA providers for your contributions. You can also transfer money from the HSA established by your employer to your own HSA.
If you decide to enroll in an HDHP and enroll in an HSA you will need to decide how much to contribute each year to the HSA. The 2022 HSA contribution limits are as follows:
Individual coverage Married or Family coverage
Maximum Contributions $3,650 $7,300
Additional permitted if over age 55 $1,000 $1,000
Contributions include any employer contributions and employee (your) contributions. If the maximum is exceeded there are substantial penalties. Be careful to watch this closely.
At a minimum you should be sure contributions are enough to meet your annual deductible. The most significant opportunity arises if you are able contribute more than your annual deductible. This allows the HSA to be a vehicle to build wealth and grow, under current law, tax free. If withdrawn for qualified medical expenses there is no tax due on distributions. If over the age of 65, funds can be withdrawn for non-medical expenses paying the same tax as you would on a traditional IRA distribution.
HSA balances can also be invested in mutual funds, stocks, bonds, as well as many other investments. For certain investment types you will need to select an HSA provider that allows self-directed HSAs. It is not uncommon for people who maximize contributions to an HSA year after year to accumulate tens of thousands of dollars.
And, by all means please use the HSA funds to pay your out-of-pocket medical expenses. Some people get so motivated by seeing the balance of their HSA grow that they do not want to withdraw funds to pay medical bills. That defeats the pre-tax benefit of the HSA. Resist that temptation!
There are many reasons to consider an HDHP with an HSA if your employer offers that option. It takes a bit of record keeping and you will have more out-of-pocket medical costs due to the higher deductible, but these costs can be paid from your HSA. The benefits for many outweigh the bit of extra effort.
Still unsure if an HDHP and HSA are right for you? Consult with your financial advisor today!
May you each enjoy good health and good finances.