Health Savings Account (HSA) [Post 4]

*This is not tax advice. Individuals should seek the guidance of a licensed professional prior to taking any action based upon the content of this post.

Who Should Read This

Young Professionals that like saving money on taxes and building wealth.

Why You Should Care

Utilizing a Health Savings Account can save you hundreds to thousands of dollars a year in taxes and create tax free investment growth in the process.

What is a Health Savings Account (HSA)?

A Health Savings Account is for individuals covered by a high-deductible health plan designed for medical expenses. No tax is paid on contributions into the account or on distributions used for qualified medical expenses. Taxable income is decreased as a result of contributions; thus, users pay less overall tax.

Common qualified expenses are medical, dental, vision, and long-term care, prescriptions, contact lenses, x-rays, surgeries, common medicines, chiropractor, birth control, childbirth, and many other expenses.

Things to Know

• It is common for employers to match part of the contribution; the maximum contribution for employer + employee for an individual in 2022 is $3,650 and $7,300 for a family.

• The account can be taken with you if you leave your current employer.

• Non-qualified withdrawals are likely to result in paying ordinary income taxes and a 20% penalty; with the penalty tax being eliminated once turning 65.

• Before considering a switch to a high deductible health plan to qualify for the account, consider the higher out of pocket expenses and higher deductible associated with these plans.

Visit the links provided to IRS.gov for more details.

Publication 502 (2021). Medical and Dental Expenses: Internal Revenue Service. (n.d.).

https://www.irs.gov/publications/p502

chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.irs.gov/pub/irs-pdf/p502.pdf

How Much Could I Save in Taxes?

1. A SINGLE INDIVIDUAL: making $60,000 in taxable income in 2022, would have a marginal tax rate of 22%. If they contributed $200 a month into an HSA account this year, they would have contributed $2,400 in total.

$2,400 multiplied by 22% is $528 in federal income taxes that would have been paid to the IRS had our friend not contributed to an HSA account and lowered their taxable income.

2. A MARRIED COUPLE FILING JOINTLY: making $120,000 in taxable income in 2022, is also in the 22% marginal tax bracket. If they contribute $500 a month into an HSA this year, they would have contributed $6,000 in total.

$6,000 multiplied by 22% is $1,320 in federal income taxes that would have been paid to the IRS if they chose not to contribute to an HSA account.

Be aware if you attempt to calculate your own potential federal tax savings, your taxable income is not taxed entirely at one tax bracket. A single person making $50,000 in taxable income will pay a portion at 22%, 12% and 10% in 2022. Search “federal income tax brackets” online for more details.

Advanced Strategy

*The following strategy may be most suitable for people with high cash flow and minimal medical expenses for themselves or immediate family without using the account in the short-term.

Health Savings Accounts are considered by the financial planning industry as being triple tax advantaged. The funds go in tax free, grow tax free, and are withdrawn tax free for qualified expenses. For this reason, some look at these accounts as incredible investment vehicles and delay using them as a medical expense account until later in life. Many banks allow investments inside the account after a certain dollar threshold.

The idea is to maximize contributions into investments inside the account over many years and allow as much compound growth as possible. This works best by paying for medical expenses out of pocket while you are young and not hinder the account’s growth potential.

Investing $250 total (from you and/or your employer) a month, for 30 years, at a hypothetical 7% return, compounded monthly, generates over $300,000 in tax free medical expense dollars (or dollars taxed as income for non-medical purposes) to use in retirement.

“So, you will own a bank account for medical expenses… and not use it for medical expenses?”

Here’s the kicker… while you allow the account to grow without taking any withdrawals, you can save your medical expense receipts and reimburse yourself from the account at any point in the future, granted you owned the account at the time of the receipt. The IRS allows this activity provided you have proof of the expense, and it is qualified.

This investment minded strategy along with the added tax savings is what makes the HSA a hidden gem.

Summary

There are a lot of great ways to use spare dollar bills that don’t involve sharing with the IRS. Consider asking your HR department if you are eligible for a Health Savings Account (HSA) and start saving on your tax bill this year. Contributing to one of these accounts is a great way to prepare for family medical expenses, hedge against accidents, and build wealth.