Want lower taxes? Contribute to your HSA.
If you haven’t yet heard the hype about the very powerful savings tool which is the Health Savings Account (“HSA”), let me fill you in.
What is an HSA?
The HSA is a tax-advantaged savings account designed to provide TAX-FREE money to pay for qualified medical expenses. If enrolled in a qualified high deductible health care plan (“QHDHP”), you are eligible to contribute up to $3,600 (or $7,200 for a family) to an HSA for a 2021 deduction. These limits are $50 (and $100) higher for 2022.
How is an HSA tax-FREE?
The HSA provides all three tax -advantaged savings benefits:
- Tax deductible – Contributions are made pre-tax, whether withheld from your paycheck or paid out of pocket followed by a deduction on your tax return.
- Tax-deferred earnings – Gains and earnings are not taxed along the way, allowing your investment to grow faster.
- Tax-free withdrawals – Distributions to cover medical expenses are not taxed.
All three of the above qualities together are referred to as a “triple tax benefit“. No other investment vehicle out there offers all three of these tax-advantaged features. It makes the HSA truly TAX-FREE.
Think about it: a Roth IRA doesn’t provide the tax deduction at time of contribution. And your 401(k) account doesn’t escape tax upon withdrawal.
When should I draw from my HSA account?
Again, the HSA is designed to cover or reimburse qualified medical expenses. With this in mind, here are three ways to be strategic with your HSA. Use it to:
- Cover current medical expenses. These distributions will be tax-free. See here for a list of expenses which qualify. You can make these distributions prior to age 65, so you may start right away. However, please consider #3 below before you decide to do this!
- Treat it like an IRA. If you are healthy enough to not spend all of your HSA on medical costs, unused balances can be distributed for non-medical purposes after age 64. These withdrawals would be taxed just like those from a tax-deferred retirement account like a 401(k) or traditional IRA.
- Reimburse past medical expenses…LATER. Here, pay medical costs out of pocket (not from HSA) while keeping record of those payments. This allows your pre-tax and tax-deferred investments to stay in the HSA account working for you. When you later want (or need) that money, reimburse yourself for past medical costs with an HSA withdrawal.
TAX-FREE and INVESTED longer!!!
- Health care coverage – Whether enrollment in a QHDHP makes sense for you is a personal matter involving your health and financial situation. For someone with expensive medical needs, the high-deductibles required under a QHDHP may not make sense financially. More expensive insurance plans with lower-deductibles are less expensive in the long-run for some people.
- Paycheck funding – If available, make HSA contributions directly from your paycheck. This lowers not only your income tax withholding but also your payroll tax (Social Security and Medicare) withholding as well.
- HSA Account Providers – If you are funding your own HSA, be selective about which provider to go with. See here for a list of top rated HSA providers. As you shop, be aware of:
- Fees – Go for a no fee option, if possible.
- Investments – Ensure that your bank offers a variety of high quality mutual funds. All the regular rules of investing (diversification, low cost funds, etc.) apply here to your HSA.
- 401(k) first – If you have a 401(k) plan at work which includes an employer match, funding that up to the match should be your priority ahead of funding your HSA.
What are you waiting for? Git to it and lower your taxes with your HSA.
- If prior to April 18th, 2022, contribute to your HSA for 2021 and lower your tax bill.
- After tax-time, begin investing in your HSA for this year.
- Put your money in…then leave it there and let it work for you!
Now that is paying yourself first…and well!
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