Do you qualify for a triple tax advantage?

Health savings accounts (HSAs) can help you cover medical expenses while taking advantage of a rare triple tax benefit. But they aren’t right for everyone.

Beyond that, there’s a lot of misunderstanding around how HSAs work, since they’re relatively new (the legislation that paved the way for HSAs passed in 2003). Let’s look at what HSAs are, how they work, and whether an HSA is right for your family.

What are HSAs?

HSAs are intended to help insurance plan participants cover qualified healthcare expenses, as determined by the IRS.

Eligible expenses include deductibles, coinsurance, medical equipment, prescriptions, and copayments. In general, plan premiums do not fall under eligible expenses, although there are two exceptions to this rule: paying for coverage under COBRA or paying your premium while receiving unemployment payments.

HSAs aim to help people save for these expenses by offering multiple tax incentives.

The triple tax advantage of HSAs

HSAs are the only account to offer three tax advantages:

  1. The money contributed to an HAS is pre-tax, meaning it lowers your taxable income for the year the contribution is made.
  2. Your money grows tax-free.
  3. Withdrawals are tax-free if they’re used for qualified medical expenses.

HSA funds have no expiration date. They’ll roll over year after year, and you can take them with you when you leave your job or switch insurance plans. This flexibility, along with the triple tax advantage, makes HSAs an effective tool for building significant savings over time.

So, while you can certainly use your HSA funds to cover medical expenses today, you can also save them up to cover future healthcare costs. This can be particularly useful for retirement planning, since healthcare costs tend to rise with age. One study showed estimated that a 65-year-old couple can expect to pay more than $300,000 on healthcare in retirement.

Using your HSA to build retirement savings

Even if you don’t face six-figure healthcare bills, HSAs can still be helpful in retirement. That’s because once you turn 65, you can use the money for non-eligible expenses, you simply lose the final tax advantage. In other words, you can still take tax-free withdrawals to cover qualified medical expenses, any other withdrawal is subject to ordinary income tax.

(Word of caution: You must wait until you’re 65. This age restriction is higher than those on traditional retirement accounts. If you withdraw funds from an HSA for nonqualified medical expenses before turning 65, you trigger a 20% penalty in addition to income tax.)

Qualifying for an HSA

While the benefits of an HSA are certainly appealing, not every person (or family) qualifies for this type of account. You must be enrolled in what the IRS deems to be a high-deductible health plan (HDHP) to qualify, per IRS guidelines. The IRS determines what constitutes a high deductible each year.

In 2024, a high-deductible plan must have a minimum deductible of $1,600 ($3,200 for families) and a maximum out-of-pocket greater than $8,050 ($16,100 for families).

If you qualify for an HSA via an employer-sponsored health plan, you may be eligible for matching contributions, depending on the firms benefits package. Any employer contributions count toward the annual maximum you can contribute to an HSA ($4,150 for individuals or $8,3000 for families).

Does an HDHP make sense?

High deductible plans aren’t right for everyone. If you and your spouse are healthy and don’t have any ongoing medical conditions, an HDHP can be a great plan to help in case of an emergency. The premiums on these plans tend to be lower, as well, which may help boost your HSA contributions.

However, if you or your family members require regular visits to specialists, physical therapy, expensive medication, or similar, a plan with high out-of-pocket costs may not make sense. The added out-of-pocket costs likely won’t offset the tax advantages of an HSA.

It’s more important for your health insurance to reflect your family’s needs in the present. While HSAs can be a great tool for retirement planning, so are tax-advantaged retirement accounts.

If you’re interested in exploring how an HDHP might impact the rest of your finances, or already have an HDHP and want to open an HSA, let’s find a time to discuss. We can look at how these updates will fit into your overall financial plan.