Big Picture, Financial Planning, Millennials

What is an HSA, Why You Should Consider One, and How To Keep Good Records

If you’re looking to save money on healthcare costs, you might have heard of Health Savings Accounts (HSAs). HSAs are a popular option for many people, but what exactly are they, and how can they benefit you?

Oftentimes I find millennials mixing up FSA’s (flexible spending accounts) and HSA’s. FSA’s are a great option for those who want to contribute, reduce their taxes this year, and then use them on health care this year. However, they do not compare to HSA’s as HSA’s have more benefits than an FSA and can be invested for the future. But.. you have to have a high deductible health plan that allows it for you to use one.

What Is An HSA?

An HSA is a type of savings account that allows you to set aside money for healthcare expenses. It’s only available to individuals who have a high-deductible health plan (HDHP). The money you contribute to your HSA is tax-deductible, and you can use it to pay for qualified medical expenses tax-free. But… you can also invest the funds in the HSA and let it grow for the future. Many know and use the first 2 benefits, but then don’t take advantage of the third and invest it. This is a powerful strategy for my high income earners out there as it has 3 tax benefits:

  1. Reduces taxable income today
  2. Investments in it grows tax free
  3. Can be used tax free on health care costs

The next question people ask me is how much they can contribute a year now. You are able to contribute $3,850 a year (single) or $7,750 (family). Not a huge amount, but still impactful.

Let’s walk through the math on how this could impact you as a high income earner. Let’s say you are in the 37% tax bracket and live in Illinois, by contributing the max, $7,750 to your HSA you will save:

  • 37% of that for federal taxes
  • 5%ish for Illinois state tax
  • Then maybe FICA (7.65%) if comes via payroll deduction

This means you could save anywhere from 42% to 49.5% on that $7,750 contribution as a high income California resident. That means you would reduce your tax bill by about $3,255 by contributing the max. That is a huge impact, and this does not even account for the tax free growth and the impact there. Obviously the higher income bracket you are in, the more impactful the tax benefits become.

Can I Reimburse Myself Years Down The Line?

One overlooked benefit is that you can reimburse yourself years later down the line. Let’s say this year you have a surgery and it costs you $10,000, you could choose to pay this out of pocket, save the receipt, and them reimburse yourself later on down the line. This gives you so much flexibility and allows you to benefit from all 3 tax advantages.

However, I do want to note that if you cannot afford the healthcare costs out of pocket, it is okay to use the funds. But if you can, let it be invested and grow.

But… make sure you are saving the receipts. Whether you use a folder on your computer or an app for this, make sure you are keeping them so you have proof. You need to be able to verify these expenses for the reimbursement in the future.

Some choose to never reimburse themselves and just let it grow to be used on health care costs in retirement which can be smart. For many people, healthcare is a top 2 expense in retirement. Having a large sum of money for this, long term care premiums, etc. can be really impactful! Plus, that gives a ton of time for growth.

What If We Have Bad Investments or Can’t Invest Ours?

A unique benefit of HSA’s is that you can roll these funds to another platform anytime you want to. This is unlike many other work related investment accounts. If you find yourself in this situation, you can roll your HSA (after you have contributed) to another low cost provider, like Fidelity, and get these funds invested however you want! It is not uncommon for a company to have an HSA but not allow for it to be invested there. This is when it can make sense to move it elsewhere yearly. Or if the investments are limited, expensive, etc.

HSA’s are one of my favorite planning tools that not enough people use, let alone use correctly! Make sure you are planning well and fit all the right accounts into your plan!