• Brenden Leese, CFP®

Do Health Savings Accounts Make Sense for You (and Your Adult Children)?


Key Takeaways

  • Healthcare costs are rising substantially faster than wages (and inflation).

  • Health Savings Accounts (HSAs) allow you to contribute and save pre-tax for future medical expenses—and the money can grow tax free even into retirement.

  • Open enrollment season is now.

With the cost of healthcare continuing to outpace inflation, more and more hard-working Americans are wondering how they’re going to pay their medical bills – even if they have good health insurance. A Kaiser Family Foundation survey found that health insurance deductibles have risen substantially faster than average wages over the last 10 years, with no sign of slowing down.

I bring this up because open enrollment for those who acquire their policies through the Healthcare Exchange ends today and I want to share one of the best kept secrets that savvy savers are using to pay for current (or expected) out of pocket medical expenses.

An HSA -- informally referred to as a “healthcare IRA” -- essentially works like an individual retirement account (IRA). You contribute to it with pre-tax dollars from your paycheck and can allocate that money into a variety of investments, depending on what your plan administrator offers. Unlike an IRA, you don’t have to wait until retirement to use your HSA. You can use it any time for “qualified” medical expenses.


HSAs are essentially “triple tax free”: (a) You fund them with pre-tax money; (b) your money grows tax-free in your account and (c) when it comes time to withdraw funds for qualified medical expenses, there is no tax on that money. How much can I sock away in an HSA?

For 2022, you’ll be able to contribute up to $3,650 a year (individual) or $7,300 (family). If you’re over 55, you can contribute an additional $1,000 a year. Another reason I love HSAs is that the unused funds roll over to future years until you need them. HSAs are not “use it or lose it” like vacation days, for example, at many companies.

If you’re in good health and don’t think you’ll need help with medical expenses while your working, HSAs can be an excellent tax-advantaged way to save for your (likely higher) healthcare costs in retirement. A 65-year old couple retiring today can expect to shell out $300,000 for health care that are not covered by Medicare during their retirement years, according to the Fidelity Retiree Health Care Cost Estimate.

Even better, HSAs can serve as a backup (last resort) emergency fund. If you suddenly need cash, you can take money out tax-free to reimburse yourself for any prior years’ medical expenses paid from outside the account. Plus, once you turn 65, you can withdraw money for non-medical uses, paying the same tax as you would on withdrawals from a pretax 401(k). What is usually covered in an HSA In addition to doctor bills, hospital stays and prescription drugs, HSAs can also pay for the following items, which might surprise you:

  • Over-the-counter medications

  • Menstrual products

  • Alternative treatments

  • Travel for health care

  • Dental and vision care

  • Guide dogs

  • Some insurance premiums

  • Medicare costs.

Portability The other reason I like HSAs is that they’re portable. You can take your HSA from one job to the next without having to cash it out or pay a penalty, and your can even use it in retirement. Unlike an IRA or 401(k) there are no required minimum distributions for an HSA. In fact, after you die, your estate can transfer the unused balance in your HSA to your spouse for continued use. Eligibility requirements One drawback to HSAs: You can only set one up if you have a “high deductible health plan” (HDHP) – currently defined as $1,400 a year or more for individuals and $2,800 a year or more for families.


How to get an HSA

So, if you have a HDHP, HSAs are generally offered by companies as an employee benefit, usually with an annual enrollment period, typically around this time of year. If you’re self-employed, you can set up an account at Fidelity or Lively, which both offer fee-free HSAs for individuals.

Why don’t more people take advantage of HSAs?

Americans have over $82 billion squirreled away in 30 million health savings accounts, according to HSA advisory firm Devenir with an average account balance of nearly $18,000. For all the potential benefits of HSAs, however, they are still under-utilized. Employees often confuse them with flexible savings accounts, or FSAs, which have been around much longer. Many employees may erroneously believe that like an FSA, the funds in an HSA must be used within the calendar year, otherwise they’re forfeited. (They are not.)

In addition, HSAs are often positioned alongside an employer’s health insurance offerings as a way to pay for health care spending. It’s therefore not surprising that 86% of funds in HSAs are used for medical expenses in any given year, according to HSA provider Lively. The good news is that there’s been an uptick in HSA adoption. According to Devenir Research’s 2021 Midyear HSA Research Report, the number of HSA accounts grew to 31 million in June, a 6% increase from the year prior.

Can you open an HSA if your company does not offer one? Yes, you can go out on the open exchange.

Real world example A client had been funding an HSA throughout his working years and kind of forgot about it. Now retired, several unexpected surgeries and medical bills came out of nowhere. When we brought up his long-forgotten HSA, he was pleasantly surprised to see his account had quietly grown to $30,000 and he was able to pay for his substantial out of pocket medical costs without dipping into his 401(k) or other retirement accounts.

Conclusion


No one knows what healthcare costs, but most likely they will continue rising faster than inflation. If you’re still working, review the pros and cons of your company’s plans carefully, and urge your adult children to do the same. We have helped many companies and individuals plan for HSAs. Please contact us any time if you have concerns about paying for your current (or future) healthcare costs.

BRENDEN LEESE is an Associate Wealth Advisor at Novi Wealth Partners