How Financial Advisors Can Help Clients Use HSAs as a Triple-Tax-Advantaged Planning Tool

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A Health Savings Account, or HSA, is a great tool Americans with a high deductible health plan can use to not only fund future medical expenses, but also as a great investment and retirement planning tool. In today’s article, we’ll review the following components of HSAs: 

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• Eligibility
• The triple tax advantages
• Bonus features

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As Americans look for more creative ways to save for both healthcare costs and retirement, an HSA can offer a number of attractive benefits. 

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Who Is Eligible for an HSA?

Before we dive into the incredible benefits of the HSA, it’s important to understand who exactly is eligible to take advantage of one. Unlike a traditional IRA, not all your clients have access to or can actually leverage what the HSA has to offer. 

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In order to be eligible for an HSA, an individual must be enrolled in a high deductible health plan (HDHP). What’s considered to be an HDHP may vary depending on the IRS definitions. In 2022, an HDHP is any health insurance plan with:

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• A minimum annual deductible of $1,400 for individual coverage or $2,800 for family. Reminder: a deductible is the amount to be paid before the insurance plan kicks in.
• Annual out-of-pocket maximums of $7,050 for individuals or $14,100 for families—including expenses such as copayments, coinsurance, and deductibles. That amount represents the most someone will pay before insurance covers in-network costs at 100%.

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One survey found that only 4% of Americans could define the bolded terms above. As their advisor, you may want to review the definitions of these terms with clients as you’re discussing their health insurance plans and costs. Most people realize that health insurance is complex—they’ll likely appreciate a quick review.

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HSA Tax Benefit #1: Sheltered Contributions

An individual with an HSA gets to experience the first of the HSA’s unique tax benefits as soon as they start contributing. That’s because HSAs can be funded with pre-tax dollars. 

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If your client is covered under an employer-sponsored HDHP with an HSA, they’ll have the option of contributing money directly and consistently via payroll. They can also contribute money themselves and later claim the appropriate tax deductions. (This is how most self-employed individuals with an HSA-eligible HDHP will reap the tax benefits.)  

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Regardless of how contributions are made, contributions to an HSA aren’t taxed up to a certain limit. In 2022, individuals can contribute up to $3,650 to their HSA tax-free, which is up from $3,600 in 2021. Families can contribute up to $7,300 in comparison to the $7,200 figure from 2021. Contributions for the 2021 tax year can still be made up to the tax filing deadline (Monday, April 18, 2022).  

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HSA Tax Benefit #2: Sheltered Growth

Once the tax-free dollars have landed successfully inside the HSA, users can start realizing the second major tax benefit: tax-free growth. 

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Contributions to an HSA above a certain threshold can be invested in the market. So for example, if the investment threshold on a particular HSA is $2,000, every contribution above a $2,000 balance is eligible to be invested. Contributions underneath the investment threshold are held in a cash account. (Depending on the financial institution, some HSAs allow for no investment threshold.) 

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All the interest that’s earned on the investments inside the account isn’t subject to taxes. This includes any capital gains, dividends, or general interest earned inside the account. HSA owners should be aware that invested funds can’t be used to make payments for qualified medical expenses—the investments have to be sold first to free up the available cash.

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HSA Tax Benefit #3: Sheltered Withdrawals 

So you can put money into an HSA tax-free, and you can grow it tax-free, but what about withdrawals? HSAs are still sheltered from taxes even when it comes time to withdraw the money from the account—as long as the money is used for qualified medical expenses. This means that you won’t have to pay income tax on withdrawals.

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With that being said, individuals can still use the account to fund non-qualified medical expenses, but please note:

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• Before the age of 65, HSA withdrawals are subject to a 20% penalty on the total amount taken out if used on non-qualified medical expenses.
• Additionally, the IRS considers the funds withdrawn from an HSA as taxable income if the money is used for non-qualified medical expenses after age 65. Therefore, the money you withdraw for non-qualified medical expenses must be included as part of your total income come tax time. 

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Because of COVID-19, what’s considered to be a qualified medical expense has expanded. If you’re interested to see many of the qualified expenses now included, check here. 

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Other Benefits of an HSA

Believe it or not, the HSA still has more to offer beyond its triple tax advantages. After being exposed to a few more of its abilities, you’ll see why an HSA can even be a powerful vehicle for retirement savings. 

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After turning 55, individuals can make catch-up contributions to their HSA just as they can with an IRA or 401(k). In 2022, individuals 55 and up can contribute an additional $1,000 annually to an HSA tax-free. 

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After turning 65, an HSA acts exactly like a traditional IRA. You can start using the money for non-qualified medical expenses with no penalty. Granted, these withdrawals will still be taxed as ordinary income, but only after taking advantage of the HSA’s tax sheltering beforehand. This makes the HSA an excellent secondary retirement savings vehicle for those who are eligible.

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Additionally, HSAs don’t require you to begin withdrawing at a specific age (unlike 401(k)s and traditional IRAs). However, you are no longer able to contribute funds to HSAs when you enroll in Medicare. You can only make contributions while you maintain an HDHP. Balances inside an HSA account also don’t have to be used in a specified time period like they do in a flexible savings account (FSA). Instead, funds in an HSA can be rolled over from year to year.

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Finally, HSA accounts can be carried with you even if you change jobs and/or enroll in a new health insurance plan. You never lose access to the funds in your account, but you can only continue contributing to the account if you enroll in another HDHP.

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Because of these extra retirement savings incentives, many people are using HSAs to contribute even more tax-advantaged money to their futures. And the funds inside an HSA can act as an extra safety net if unexpected medical expenses occur in any given year, regardless of the individual’s age. 

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Let Caribou Help You Leverage the Benefits

At Caribou, we understand that while you’re an expert comprehensive financial advisor, the decision around whether an HSA/HDHP makes sense for your clients is more than just a tax decision. High deductible plans leave clients exposed to larger and more varied healthcare expenses, meaning that there are things like the client’s health and medical needs that need to be considered. 

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We partner with financial advisors across the country to provide them with the necessary resources to educate themselves and their clients. By working with us, advisors are given access to an entire suite of tools that provide insights and potential opportunities to improve their financial planning process. 

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An HSA is a powerful tax sheltering solution that you may be able to provide your clients. Furthermore, it can serve as a supplemental retirement account once they turn 65. However, the HSA may only be the beginning of the value you can provide by improving your overall health insurance knowledge. To see if we can help you generate more value for your clients, reach out to us or click here to schedule a conversation today.