In 2016, 29% of insured workers were enrolled in a HDP (High Deductible Health Plan). HSA's are a tax-advantaged savings vehicle that are available to those enrolled in an HDHP. An HDHP charges lower premiums than a PPO, but has higher out of pocket deductibles. An HSA allows you to put away money on a pre-tax basis to be used to pay for medical expenses at a future time. The investment grows tax free and is never taxed if used to pay for medial expenses. Many people are choosing to pay for their current medical expenses out of pocket, and are allowing the money to be invested in an HSA that grows tax free. They then take the money out at a much later date on a tax-fee basis.
HSA withdrawals must be used for qualified medical expenses such as doctor visits, medications and other expenses that are able to be deducted on a tax return. You can make a withdrawal at any point in the future for any qualified expenses that are incurred since you opened the account, so you do not have to make a withdrawal from your HSA this year just because you incurred the expense in the current year.
To give a simple example, assume you have a gross income of $100,000. After a 25% federal tax, a 5% state tax, and a 7.65% FICA tax, a dollar of marginal income would be worth 62 cents. If you incurred a $2,000 bill for braces, if you paid for this on an after tax basis, you would need to pay $3,226. If you used your HSA to pay for this, you would be paying for it with pre-tax dollars, and would only need to use $2,000, saving you $1,226 for this bill.
If you already maximize your contributions to your 401(k) account, you can fund the HSA and use it as a retirement savings account. You can allow the assets to compound and grow as long as possible, and pay out of pocket medical costs with current funds. In the above example, if you had saved the receipt for the $2,000, you could withdraw this 30 years later when the assets have grown, and the withdrawal would be tax free. The assets accumulated in your HSA can also be used much later to pay for medicare premiums or long term care insurance.
When comparing this to a 401(k), they are both made on a pre-tax basis , so they reduce your taxable income in the year you make the contribution. They both grow on a tax deferred basis, but the main difference is that the HSA distribution is tax free at the time of the withdrawal. The 401(k) distribution is taxable when withdrawn.
Most people just use the HSA to pay for current year medical expenses, but the HSA can also be used as an effective retirement planning strategy. If you would like help determining the best strategy for your retirement, please contact me to set up a meeting to review your financial goals and how to best achieve them.