Here’s How Health Savings Accounts Offer a Triple Tax Benefit
One of the greatest benefits of being covered under a High Deductible Health Plan (HDHP) is the ability to save into a Health Savings Account (HSA) and receive tax-preferred treatment on money saved for medical expenses.
Specifically, HSAs provide a triple tax benefit. Contributions are made either pre-tax if offered through your employer or tax-deductible if set up independently.
Once in the HSA, a portion of the money is required to be kept in cash, but any amount in excess of that requirement can be invested.
Those investments can grow the balance of the account tax-free. If the money is taken out of the HSA for a qualified health care expense, the contributions and the investment growth come out tax-free.
HSAs are an excellent way to pay for current and future healthcare needs on a tax-advantaged basis.
For an HDHP to qualify to use an HSA, the minimum deductible in the plan for 2023 is $1,500 for an individual or $3,000 for a family.
The plan must also have an annual out-of-pocket maximum of $7,500 for self-coverage and $15,000 for families. These maximums cap your out-of-pocket expenses.
What are Health Savings Accounts Used For?
An HSA is used to save money to pay for out-of-pocket medical expenses not covered by your health insurance plan, such as a deductible, copays, coinsurances, prescription drugs, dental expenses, and vision care.
Unfortunately, you cannot pay your monthly insurance premiums using an HSA unless you are over age 65 and paying for your Medicare premiums. Premiums for Medicare supplemental or Medigap policies are not treated as qualified medical expenses.
What is the Annual Contribution Limit for Health Savings Accounts?
The IRS recently announced an increase to the annual contribution limit for 2023.
- For a single individual on an HDHP, the maximum contribution amount is $3,850.
- If more than one person is covered under the HDHP, the maximum contribution amount is $7,750.
- There is a $1,000 catch-up contribution amount if you are over age 55.
These amounts are tax-deductible when reporting your taxable income.
Many employers offset a portion of your health care costs by making contributions to your HSA. Although you may not deduct any contributions made by your employer, those amounts are generally excluded from your gross income, meaning they are tax-free.
In addition, the contribution limits remain the same whether the contributions are made by you or your employer. For example, if your employer contributed $1,000 to your HSA, the amount you may contribute, and deduct, is reduced to $2,850 or $6,750, not the full $3,850 or $7,750.
How Often Can You Contribute to a Health Savings Account?
Contributions to your HSA can be made throughout the year or in one lump sum.
To encourage you to maximize your HSA contribution benefit, if the annual contribution limit is not reached by year-end, you may continue to make contributions to your HSA through the tax return filing deadline the following year (without extensions) until the limit is reached.
On the flip side, if you make a withdrawal for non-eligible medical expenses before age 65, you will have to pay tax on that amount plus a 20% penalty. With tax and penalty combined, over 50% of the distribution could be forfeited. If you are 65 or older, there is no penalty, but the withdrawal amount is still taxed.
Another benefit of owning an HSA is that you may keep your HSA open and continue to enjoy tax-free growth and tax-free withdrawals even if you are no longer eligible to make contributions. This means that when you are no longer enrolled in an HDHP, or if you change employers or leave the workforce, your HSA can remain open.
With a better understanding of how HSAs operate and their benefits, it is easier to appreciate their value. As the owner of a Health Savings Account, you will get not only the triple tax benefit of tax-deductible contributions, tax-free earnings, and tax-free withdrawals, but also the opportunity to build a healthy medical nest egg to cover current and future health care expenses.
Jeff Witz, CFP® welcomes readers’ questions. He can be reached at 800-883-8555 or at firstname.lastname@example.org.
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