Imagine holding an asset that enjoys the contribution benefits of a Traditional IRA and the distribution benefits of a Roth IRA. What investment portfolio wouldn’t benefit from this kind of tax-efficiency? Read on to learn about the increasingly popular Health Savings Account – the only type of account that is never taxed if used properly.
As the name suggests, a Health Savings Account (HSA) is a tax-advantaged way of setting aside money for healthcare expenses. Contributions are made by an individual (or employer) on a pre-tax basis, thus lowering one’s taxable income. That money is then available for immediate tax-free withdrawals so long as it is used for qualifying medical expenses. This makes HSAs a nifty way to cover everyday healthcare costs like doctor visits, prescriptions, or even contact lenses. An HSA can be a great short-term asset, but as we look at the big picture the case gets even more compelling.
HSA money never expires. On top of that, funds within an HSA can be invested to gain market exposure all while growing tax free. That’s an especially good thing since, for most of us, the majority of our significant medical expenses will occur later in life and likely in our retirement years. A strong retirement plan considers and plans for these expected health costs anyways– often to be covered by an IRA, 401(k), or other long-term asset. Taking advantage of the flexibility and unprecedented tax-advantages of an HSA make it a powerful vehicle for any financial plan.
Contributions to an HSA can only be made in years when enrolled in a High-Deductible Health Plan (HDHP) and is subject to certain deductible minimums ($1,300 for self-coverage or $2,600 for a family plan -- in 2016). The affordability of HDHP premiums amidst rising health insurance costs are one reason HSAs have gained popularity in recent years. Many employers that opt for the lower premiums of an HDHP will instead make regular contributions to the employee’s HSA account as part of their benefits package.
Limits also exist to the amount that can be contributed in each tax-year ($3,350 for singles and $6,750 for those under a family plan – in 2016). Additionally, once money is contributed to an HSA account there is no going back. There is not the ability to transfer out or otherwise re-characterize the funds. The account holder will pay a 20% withdrawal penalty and lose the associated tax benefit should they need to access the funds for anything other than a qualified medical expense, even financial hardship.
A Practical Example
In most cases, the flexibility and practicality of an HSA easily overcomes its limitations. I recently heard the story of a young married couple that illustrates this well. With a household of two working adults and no dependents, this couple was faced with a heavy tax burden come April. Further yet, the amount they were allowed to deduct by contributing to a Traditional IRA was capped due to their income level. Luckily, the couple held an HSA account and HDHP through the husband’s employer. The couple made no previous 2015 contributions to the HSA beyond those made by the employer. Rather than deplete their cash to Uncle Sam, the couple was able to make a one-time contribution to their HSA (like an IRA, you are given until Tax Day to do this). The contribution was 100% deductible and thus lowered the amount of tax they owe. Here is how the math worked:
By maxing out the Contribution Limit ($6,650 for a family plan in tax year 2015), the couple was able to reduce their taxes owed by $2,462! Indeed they needed an additional $2,188 in liquid cash ($4650 paid less the $2,462 that would have been needed for taxes owed), but the significant tax savings means their overall net assets are much higher. Hoping to start a family soon anyways, the couple can now opt to earmark their HSA funds towards costs associated with having a child or save and invest them for the long-term.
The old adage reminds us that death and taxes are life’s two certainties. An HSA doesn’t omit anyone from either, but when used properly it absolutely can lower the tax burden while securing necessary funds to cover significant healthcare needs. Addressing future healthcare needs by way of an HSA is ultra-efficient and therefore incredibly freeing. Imagine being freed from the worries of future healthcare costs! An HSA can be one way to create a more stable, generous, and eternally focused financial plan.
Interested in having a conversation about how an HSA could benefit your situation? Let’s sit down and talk about it. The first consultation is always free. Reach out to me at Wacek Financial Planning today!
About Wacek Financial Planning
Founder, Ben Wacek, is a fee-only, Certified Financial PlannerTM who has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective, using Biblical principles. If you’d like to learn more about Wacek Financial Planning, please visit www.wacekfp.com.
See IRS Publication 969 for more information about Health Savings Accounts and their tax-implications.
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