Anh Thu Tran
Tax-favored health plans
To help reduce the burden of health care costs, the government has created an alphabet soup of supplemental health care savings accounts. These accounts – Flexible Spending Account (FSA), Health Savings Account (HSA), Medical Savings Account (MSA), Medical Expense Reimbursement Plan (MERP), Voluntary Employees Beneficiary Association (Plan) (VEBA) and others – have left many workers feeling overwhelmed and confused. Currently, the most recognizable health care savings plans are FSA and, more recently, HSA. While many workers are familiar with the “use-it-or-lose-it” requirement of spending assets in an FSA, not as many are acquainted with an HSA and how it may help cover some short- and long-term medical costs more tax-efficiently.
Health Savings Account (HSA)
An HSA is a tax-advantaged savings account that allows you to put aside money to pay for qualified medical expenses. Unlike other savings accounts, an HSA is triple-tax free. Like a traditional IRA, HSA contributions are tax-deductible (for eligible participants) and gains are tax-deferred. Like a Roth IRA, HSA withdrawals are tax-free if used for qualified medical expenses. To qualify for an HSA, you have to use a high-deductible health insurance plan.
In 2017, minimum deductibles to qualify for an HSA are $1,300 for an individual and $2,600 for a family. The maximum annual HSA contribution is $3,400 for individual and $6,750 for family. These amounts increase by $1,000 for those 55 and older. The maximum age you can contribute to an HSA is 65 when you become Medicare eligible.
HSA: Pros and cons
Introduced in 2003, HSAs have grown exponentially over the past five years. As of December 31, 2016, there are 5.5 million HSA accounts with total assets of $11.4 billion. This upward trend will likely continue as more employers (mostly those with 500-plus employees) offer HSA-eligible health insurance plans. As HSAs become more prevalent, it’s important to know the pros and cons so that you can make informed decisions.
HSA tax-free account assets can be used to pay for qualified medical expenses each year. (Learn more.) Unused HSA account balances can be invested like other retirement savings accounts (e.g., IRA, 401k) and utilized at a future date. This allows them to compound and potentially grow significantly.
There are a number of cons with HSAs as well, starting with the need to have a high-deductible health insurance policy. While more and more employers are offering this option, it is not yet widespread. Compared to other tax-advantaged savings plans (e.g., 401k), HSA contribution limits are low. Many HSA plans have high administrative fees that make them expensive, and some plans include only high-cost mutual fund investment choices. Such costs can erode savings. (See Exhibit 1 for Morningstar’s assessment and ranking of the largest plans for spending and investments. Also, click here to read more.)
Exhibit 1: Here is a list of how Morningstar has ranked major HSA plan providers based on key criteria, 2017.
Leverage HSA to help save for (retirement) health care expenses
If you qualify for an HSA, it’s generally a good idea to take full advantage of it by contributing as much as possible. For those who have to pay out-of-pocket for medical expenses and lack other resources to do so, it may make sense to use the HSA as a medical expense spending account. Simply, park pre-tax savings in cash and then use the account assets to pay off expenses as they come due.
However, for those who are in good health, have other means to pay for short-term health care expenses and have a long(er) time horizon (10 years or more), it may make more financial sense to invest HSA savings. This will give the principal an opportunity to grow. Depending on your income tax bracket now, assumed tax bracket when you make future withdrawals, and the tax character of your other retirement income resources, it may even make sense to withdraw from IRA and/or 401k accounts before using HSA money. This allows HSA savings to grow tax-free longer. This may be useful as health care expenses typically increase later in life. Finally, keep in mind that, unlike IRAs, only an HSA account holder’s spouse can inherit the account and enjoy an extension of tax-benefits. Other beneficiaries have to report an HSA inheritance as income. This is an important consideration when designating beneficiaries for different assets / accounts.
It’s estimated that the average 65-year-old, retired couple will spend $260,000 out-of-pocket for medical expenses over their lifetime. Those who are able to save in an HSA and invest the principal long-term could cover future health care costs more efficiently. Income tax rates, personal health and the unknown costs increases of health care will all influence the ultimate usefulness of an HSA.
 Most HSA owners use it as a savings account rather than an investment account. As of 2016, only 4 percent of accounts have investments other than cash. (Source: Trends in Health Savings Account Balances, Contributions, Distributions, and Investments, 2011‒2016: Statistics from the EBRI HSA Database, EBRI, July 2017.)
 “The real cost of health care in retirement,” Barron’s, February 2017.
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