If you could choose any super power, what might it be? Invisibility? X-ray vision? We can’t help you shoot cobwebs out of your palm, but how about the triple- power to set up a savings account that is funded, invested and spent, all tax-free? For some households, under some circumstances, the opportunity may exist, in the form of the Health Savings Account (HSA).
Defining the HSA
HSAs are tax-advantaged vehicles available exclusively to those with high-deductible healthcare plans. If you fall into this category, you can fund your HSA with pre-tax dollars. The dollars then grow tax-free, and are tax-free when you take them out – as long as they are spent on healthcare expenses. The rules on what qualifies as a healthcare expense are relatively broad.
Describing the HSA
Some households find themselves in a high-deductible healthcare plan because they and/or their employer cannot afford the lower deduction, even though they would like to have it in place. The general idea behind the HSA is to help them set aside reserve funds to cover the high out-of-pocket deductions they face before their regular coverage kicks in.
Others who could afford the higher premiums and lower deductibles may deliberately choose a high-deductible plan anyway, particularly if they are relatively healthy. By crunching the numbers, they may determine that they’re likely to get the best value by self-insuring for their basic healthcare costs, and establishing lower-cost insurance to cover catastrophic events.
For these healthy, high-income households, the HSA can offer additional financial planning possibilities, particularly for those who manage the account within their overall investment strategy. By fully funding their HSA and then paying for as many medical expenses as possible out of pocket, they create a strategy for lowering taxable income while creating the equivalent of a “medical IRA” for the years when their paychecks diminish or disappear. This can work well for at least a couple of reasons:
- HSAs are NOT “use it or lose it” plans. Unlike flexible spending accounts, unused HSA assets automatically roll over from year to year, so the assets can build over time.
- At age 65 or older, you can use HSA money on any expenses, not just healthcare-related. Once you’re 65, if you spend HSA assets on non-healthcare costs, you’ll owe taxes on the withdrawals, but no penalty. In this sense, the HSA begins to resemble a traditional 401(k) or IRA, with an added tax advantage for healthcare costs.
Establishing and funding an HSA is not available to or appropriate for everyone. If you do go there, we recommend setting up sufficient liquid savings earmarked as a medical safety net, to prevent your carefully laid plans from going awry should the unexpected occur. (As someone whose otherwise-healthy family experienced a major and wholly unexpected car accident several years ago, I can personally attest to how comforting that extra coverage can be if you end up needing it!)
Christine Benz of Morningstar offers additional insights on HSAs in her November 2013 piece, “Reconsider Your Decision to Skip the Health Savings Account.” And, as always, we at SageBroadview are available to discuss the details of your personal circumstances to help you determine a sage course for you and your family’s financial health.
Sage Serendipity: Speaking of healthful resiliency, here’s an inspiring rendition of the song Pharrell’s “Happy,” by the Detroit Academy of Arts and Sciences choir. Be sure to stick around for the adorable hand wave at the end.
Sheri Iannetta Cupo, CFP®, is a Principal of SageBroadview Financial Planning based in Morristown NJ, and Farmington CT, an independent, Fee-Only Registered Investment Advisory firm, specializing in providing busy professionals and their families with holistic financial life planning and investment management services. You can find more here: www.sagebroadview.com where this post originally appeared. You can also connect with Sheri on Twitter, Google+ and LinkedIn.
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