Shortly after starting my job in New York, I was given an option between a high deductible and a low deductible health insurance plan. At that time, I didn’t even know how health insurance worked. At that time, I only knew that the difference between a high or low deductible health insurance was the cost so instinctively I went with the high deductible health insurance plan. Opting for a high deductible health insurance plan meant that I was eligible for a Health Savings Account (HSA) which is an account that you can contribute with pre-tax dollars to spend on qualified medical expenses. Only looking at how much contributions would take from my paycheck, I didn’t contribute anything until I learned that there are several benefits to maxing out my allowed contribution amount to my HSA which I’ve listed below.
1. Tax Free Contributions and earnings growth
Contributions towards an HSA are usually made with pretax income through payroll deductions from your employer. This means that your contributions won’t show up as part of your gross income and not be subject to federal income taxes. For 2021, an individual can contribute up to $3,600 and $7,200 for families per year. For those aged 55 or older, you can contribute an additional $1,000 at the end of the tax year. On top of your tax free contributions, some HSA accounts allow you to invest your contributions tax free. Several HSA accounts don’t let you invest until you have at least a certain amount which should encourage you to contribute earlier.
2. HSA contributions don’t expire
You’ve heard the saying, “if you don’t use it, you lose it.” Luckily, this does not apply with HSA contributions meaning that any money that is left in your account rolls over to the next year and so on. This means that you do not lose any of the money in your HSA or the interest that it accrues which allows the remaining amount to grow tax free as mentioned above. In contrast, if you had a Flexible Spending Account (FSA) which is similar to an HSA but differs in that contributions must be used within the tax year or the funds will be lost. The money you have in your HSA is yours to keep forever and if you were to decide to quit your employer, you are able to inform your existing HSA provider to close your account and transfer the funds to another provider.
3. Tax Free Withdrawals
Contributions made to you HSA can be used to pay for qualified medical expenses including health care, dental, and vision expenses for yourself, your spouse, or eligible dependents. Any of your withdrawals from you HSA are not subject to federal taxes as long as they are used to pay for qualified medical expenses. To make it easier, Amazon has an HSA eligible shop that allows you to purchase HSA or FSA eligible medical supplies and equipment. Though you may be a young healthy individual thinking that you have no need to buy any medical equipment, you’ll be surprised how expansive the eligible medical expense list is. The Amazon HSA store includes items you use quite often including mouth wash and sun screen. In hindsight, although you may not use any of these items now and knowing that there would be a greater need the in the future, it would be practical to contribute to your HSA to be able to withdraw tax free in the future.
Fidelity estimates that an average retired couple age 65 in 2021 may need roughly $300K of after tax savings to cover health care expenses. This amount may seem daunting, but contributing the maximum to your HSA can help you chip away at this figure. For example, if you were to contribute the maximum contribution of $3600 every year for 25 years assuming an average rate of return of 8% coupled with a 24% federal income tax and 5% state income tax, you would roughly have $285K in your account. This means if you started contributing the maximum allowed amount at age 25, you’d have $285K in your HSA account by age 50 and $440K by age 55. Now we all know that this is an ideal situation and life happens which may force you to dip into your HSA to pay for medical expenses thus throwing off our calculation. However, if we want to play it safe and hedge against the likely possibility that at some point we will need to pay for some sort of medical expenses in the future, it would be prudent to put money aside in your HSA. Given all your contributions to your HSA is yours indefinitely, contributing either the maximum allowed amount or any amount less than that gives you three tax advantages including tax free contributions, earnings, and withdrawals.
