A popular investment vehicle among savvy investors is an HSA (Health Savings Account). These accounts offer tax-savings benefits both today and many years in the future.
HSAs are known for their triple-tax benefits:
- Contributions made reduce today’s taxable income
- Investment growth is tax-free within the account
- Qualified distributions are tax-free
That’s right! Unlike your normal investment account or 401(k) at work, HSAs have the potential to shelter your income so that you NEVER pay taxes on the money. While it might sound too good to be true, there are some rules and factors to consider before jumping in.
Here are some factors to consider before choosing an HSA:
What is an HSA?
An HSA is a Health Savings Account that allows you to save for medical expenses. In order to qualify for these accounts, you must be enrolled in a High-Deductible Health Plan (HDHP) for your health insurance. While these plans usually have lower monthly premiums, the out-of-pocket costs are much higher than typical health insurance plans. For 2022, the maximum out-of-pocket costs are $7,050 for individuals and $14,100 for families.
If you have a HDHP at work, you can defer a portion of your paycheck directly to your HSA account. Just like with your 401(k), these contributions will reduce your taxable income. If you have health insurance through a Marketplace, like Covered California, you can make contributions directly to your HSA account via electronic transfers or by mailing a check.
How much can you contribute?
So what’s stopping you from putting as much money as possible into an HSA? The IRS! Each year, the IRS sets limits for how much you are eligible to contribute to your HSA. If you contribute too much in a given year, you will be charged a 6% penalty for each year that the excess contribution remains in your account.
For 2022, the contribution limits are $3,650 (for individuals) and $7,300 (for families). If you are age 55 or older, you are able to contribute an additional $1,000. The IRS just recently announced that the 2023 contribution limits will be $3,850 for an individual and $7,750 for families.
What can you use them for?
In order to qualify for tax-free treatment of your distributions, they must be used for qualified medical expenses. These expenses typically include medical copays, deductibles, prescriptions, dental, or vision expenses. You can find a comprehensive list of qualified expenses here.
If you take a distribution from your HSA and don’t use them for a qualified medical expense, then the distribution will be taxed as ordinary income and subject to a 20% penalty. For example, let’s assume a single taxpayer that earns $100,000 takes a $2,000 unqualified distribution. They can expect to owe $880 in taxes and penalties (24% + 20%) on the distribution.
Understanding the pros and cons of Health Savings Accounts can help optimize your medical expenses and tax savings. If you would like to work with a financial planner to walk you through your options, I would love to help you!
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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.