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Healthy habits for health savings accounts

Anchored Development

Reprinted, FIDELITY VIEWPOINTS – 11/05/2020 – 9 MIN READ

More and more employers are offering HSA-eligible health plans to their employees. These plans are also known as high-deductible health plans (HDHPs) and are paired with HSAs. If your company offers this option and you are not taking advantage of it, you may be missing an opportunity, as HSAs can play a valuable role in your financial wellness.

Tip: If you are already enrolled in an HSA-qualified health plan, but do not have an HSA to which your employer is making contributions, consider opening an HSA account. (Since HSAs are portable, you can transfer account balances in HSAs from any of your previous employers to a new HSA.)

In the past, you may have heard that HSAs were a convenient way to pay for out-of-pocket costs, such as doctor visits or prescriptions at your local pharmacy. But did you know that HSAs can be used in a variety of ways to help manage other current qualified medical expenses—as well as for future qualified medical expenses—even after you retire?

HSAs: The basics

HSAs are accounts that work in conjunction with an HSA-eligible health plan to allow employees to cover qualified medical expenses. If you put money in an HSA and use that money to pay for a doctor visit or another qualified medical expense anytime now or in the future, you’ll never pay federal taxes on that money. And although state taxation may vary, most states follow the federal tax law.

What’s more, unlike health flexible spending accounts (FSAs), HSAs are not subject to the “use-it-or-lose-it” rule. Funds remain in your account from year to year, and any unused funds may be used to pay for future qualified medical expenses.

The 2020 IRS contribution limits for health savings accounts (HSAs) are $3,550 for individual coverage and $7,100 for family coverage. For 2021, the limits increase to $3,600 for individual coverage and $7,200 for family coverage.

If you’re 55 or older during the tax year, you may be able to make a catch-up contribution, up to $1,000 per year. Your spouse, if age 55 or older, could also make a catch-up contribution, but will need to open their own HSA.

You can use your HSA to pay for some or all of your qualified medical expenses each year and let the rest of the money in your HSA potentially grow for use in the future, including in retirement. Or, if you have the cash to pay your medical costs out of pocket, you can let your entire HSA grow tax-free for future qualified medical expenses.1

3 healthy HSA habits

Consider how these 3 “healthy habits” can help you get the most value from your HSA, both now and in the future:

1. Cover anticipated out-of-pocket health care costs 
Each year, during annual enrollment, you have the opportunity to make health care choices that serve the needs of you and your family for the coming year. You may be wary of enrolling in an HDHP because you are concerned about potential out-of-pocket costs. You may worry, “What happens if I get really sick or have a catastrophic accident? Where will I get the money to pay the higher deductible?”

These are valid considerations. To start with, you should factor in the deductible and any out-of-pocket costs. But what you may not realize is that you may be paying more than $2,000 every year in premiums for a “lower-deductible” plan—such as a traditional preferred provider organization (PPO) plan—whether you need services under the plan or not.

Those who elect an HSA-eligible plan typically pay a lower premium for health coverage and can direct those premium savings to their HSA to help cover any “worst-case” expenses. HSA-eligible plans also generally provide generous coverage above the higher deductible, including an out-of-pocket maximum for protection. What’s more, most preventive care and screenings are typically covered 100% by insurance, including HSA-eligible plans.

Tip: Consider how much cash on hand you may need to cover anticipated or unanticipated qualified medical expenses at any one time. If you’re not sure how much to set aside in cash, you may want to start by keeping your plan’s in-network deductible in cash and then make changes over time as needed. Then, you can invest the rest of your HSA dollars for the longer term, perhaps for use in retirement.

Also, while you cannot be enrolled in a general-purpose FSA if you elect an HSA-eligible plan, more employers are offering the option to enroll in an HSA-eligible FSA—meaning you could set aside up to $2,750 pre-tax in a limited-purpose FSA2 to pay for current year dental and vision expenses. However, your employer sets the maximum level allowed, which could be less than the $2,750 noted here, and unlike an HSA, the amount you set aside in an FSA will typically face use-it-or-lose-it rules each year.

2. Take advantage of available employer contributions 
If your company supports your efforts to save with an employer contribution to your HSA, you’re in good company. In 2019, 27% of all HSA dollars contributed to an HSA account came from an employer. The average employer contribution was $880.3

Combined with your own contributions, the contributions from your employer can go a long way to meeting any anticipated qualified medical expenses. While employers may have different rules and timing for their contributions, a common approach is for employers to deposit their full annual contribution into your account at the beginning of the year or as soon as you enroll in the HSA-eligible health plan and open your HSA.

3. Save and invest for future qualified medical expenses 
Most financial professionals suggest that individuals can benefit from tax-advantaged vehicles such as workplace savings plans and HSAs. While individual tax situations will vary, the triple tax advantages offered by HSAs merit a closer look. Generally, an HSA-eligible health plan with an HSA enables you to set aside pre-tax dollars through payroll deductions.

An HSA can also be funded with after-tax dollars, which the individual then takes as a tax deduction on their personal taxes. These contributions can accumulate tax-free and can be withdrawn tax-free to pay for current and future qualified medical expenses, including those in retirement.4 An HSA balance can remain in your account from year to year, and you can take it with you should you switch employers or retire.

HSAs can positively impact your tax situation. For example, an individual in the 22% federal income tax bracket could potentially save nearly 30% in taxes (federal income + FICA + potentially state income) on each dollar contributed to the HSA through a pre-tax cafeteria plan. The tax benefits of HSAs are a good way to help you save.

According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2020 may need approximately $295,000 saved (after tax) to cover health care expenses in retirement.

For many Americans, health care is likely to be among their largest expenses in retirement. Fortunately, employees who have access to an HSA-eligible health plan through their employer may have the option of saving and investing in an HSA. Investing for retirement is a priority for most Americans, and investing in a tax-advantaged HSA to help pay for current or future qualified medical expenses is becoming just as important.

Tip: Consider contributing the maximum that you can afford to your HSA, up to your maximum annual contribution limit. Think about ways you can stretch your budget to put aside a few more dollars to pay for health care expenses this year and in the future. You should also consider investing the portion of the HSA that you are saving for the future in an asset mix in line with your longer-term savings goals.

4 ways to use your HSA in retirement

You can always use your HSA to pay for qualified medical expenses like vision and dental care, hearing aids and nursing services. Once you retire, there are additional ways you can use the money:6

1. Help bridge to Medicare 
If you retired prior to age 65, you may still need health care coverage to help you bridge the gap to Medicare eligibility at 65. Generally, HSAs cannot be used to pay private health insurance premiums, but there are 2 exceptions: paying for health care coverage purchased through an employer-sponsored plan under COBRA, and paying premiums while receiving unemployment compensation. This is true at any age, but may be helpful if you lose your job or decide to stop working before turning 65.

2. Cover Medicare premiums 
You can use your HSA to pay certain Medicare expenses, including premiums for Part B and Part D prescription-drug coverage, but not supplemental (Medigap) policy premiums. For retirees over age 65 who have employer-sponsored health coverage, an HSA can be used to pay your share of those costs as well.

3. Long-term care expenses 
Your HSA can be used to cover part of the cost for a “tax-qualified” long-term care insurance policy.7 You can do this at any age, but the amount you can use increases as you get older.

4. Pay everyday expenses 
After age 65, there is no penalty if you use HSA money for anything other than health care. But you will have to pay income tax, similar to pre-tax withdrawals from your 401(k).

Tip: Generally, a person approaching retirement and planning to use their HSA for retirement medical expenses should consider investing somewhat less aggressively than they do for other retirement assets, given the shorter investment horizon for HSAs.

Summary

HSAs offer a number of benefits: not only spending for the short term, but also saving for longer-term qualified medical expenses, including those in retirement. The healthy habits outlined here can help you better understand how to take advantage of this growing health care savings opportunity.

Key takeaways

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