Healthcare

The Tax Benefits of Health Savings Accounts

The Tax Benefits of Health Savings Accounts

Taxpayers who select a high-deductible health insurance plan (as defined by the government) are eligible to sign up for Health Savings Accounts (HSA). Though these specialized accounts are described as a way of empowering policyholders to make their own spending decisions when it comes to their medical expenses, their true superpower may lie in the triple tax benefits that they offer.

The History of HSAs

HSAs were first introduced in late 2003, but a study conducted five years later revealed that though millions of people had signed up for policies that qualified them for HSA accounts, fewer than half had opened one — and those that did had higher average incomes than other tax filers. Interestingly, the contributions that these account holders made were roughly double what they had withdrawn to apply for eligible medical expenses. The high earners had spotted the remarkable tax benefits that the HSAs offered, and were making the most of it.

The Three Tax Advantages of HSA Accounts

HSA accounts were designed to reduce health care costs, to provide policyholders with controls over their benefits, and to encourage saving for future health care expenses. But they offer a combination of three tax advantages that make them a unique and savvy investment. The three advantages are:

  • Pre-tax Contributions – All deposits made to an HSA account are pre-tax. For tax year 2021 a single individual can deposit up to $3,600 ($3,650 for 2022) into an HSA account (a family can contribute up to $7,200 ($7,300 for 2022) and those who are 55 or older can deposit an additional $1,000 per year until they are eligible for Medicare.) Employees whose contributions are deducted from their paychecks have the money taken out before it is taxed, and those who make their own deposits can deduct the amount invested from their taxable income – even if they don’t itemize.
  • Tax-free Growth – The money that is deposited into an HSA account can earn interest, and can even be invested, with no tax impact. The growth in the value of the account will not be taxed, and is not subject to the required minimum distribution that investors in IRAs or 401(k)s have to comply with by a certain date. The money can continue growing in the account for as long as the individual wants it to.
  • Tax-free Distributions – When an account holder withdraws money from their HSA account, they do not have to pay taxes on their distributions as long as the money is spent on qualified medical expenses, which include physicians’ bills, prescriptions, eyeglasses, hospital fees, and many other charges. Withdrawing the money for non-eligible expenses will result in both taxation and a 20% penalty until the individual turns 65. After that point they will still be taxed but will not be penalized. 

Each of these tax advantages is valuable, but HSA accounts stand alone in offering all three. 

Why Doesn’t Everybody Open an HSA Account?

As attractive as HSA accounts are for those who want to take advantage of their tax benefits, it is important to remember that they are only available to those who opt for a high-deductible health insurance plan. These plans are strictly defined in terms of the minimum amount that a policyholder must spend out-of-pocket and the maximum amounts that a policyholder can spend out-of-pocket, but in all cases a policyholder is likely to find themselves paying more than is true for other types of plans. If you are young and/or in good health and unlikely to need a significant amount of medical care, then a high-deductible health insurance plan may make good sense for you. Not only can you benefit from the tax advantages of the HSA account, but you are also going to spend substantially less on your policy premiums than you would on a plan with a lower deductible and more coverage. If, on the other hand, you are anticipating major medical expenses as a result of a chronic condition, a planned medical procedure, or even a bevy of sports-minded offspring who require intermittent emergency room visits, then a high-deductible plan may not make sense for you. 

A Few Closing Thoughts

If the tax benefits offered by an HSA account are worth the downsides of a high-deductible health policy, here are a few more things you should keep in mind:

  • Unlike Flexible Spending Accounts (FSA), you can keep any money that you don’t spend indefinitely – even if the plan is offered through an employer. There is no deadline for spending the money on qualified medical expenses, and the balance in the account belongs to you.
  • Though you can use your HSA account to pay for copays, co-insurance and deductibles, in most cases you will not be able to use its funds to pay for insurance premiums.
  • You can no longer contribute to an HSA account once you are eligible for and enrolled in Medicare, though you can use the money for qualified medical expenses at any time, without being taxed on disbursements.
  • HSA account funds can be invested in mutual funds and other investment vehicles.
  • If you are married and your spouse is covered on your health insurance policy then you are both required to enroll in a high-deductible plan, which must be your only health insurance.
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Spencer Wilson

Spencer Wilson

Spencer Wilson, EA is a tax preparer based in Long Beach, CA. Spencer Wilson Financial Management Services has been serving the Greater Los Angeles Area and Orange County since 2004. <br /> We began in the heart of Naples in Long Beach and we continue to work hard offering tax preparation and planning, business accounting and bookkeeping and payroll services . <br /> We have helped many different people and businesses succeed financially and take control over their finances.

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