For most people, the go-to method for lowering annual income taxes is to maximize retirement savings in a qualified retirement plan, such as a 401(k) or 403(b). However, another way to reduce your annual income tax liability — and save for future health care costs — is by participating in a health savings account (HSA).
An HSA is a triple tax-advantaged account that works as a personal savings account to be used for current or future qualified health care expenses throughout your life. Your contributions are tax-deductible (or pretax if you contribute through your employer), the money grows tax-deferred, the balance can be invested, and you can use it tax-free for eligible medical expenses at any time. While you are healthy, it is a great way to save for future qualified healthcare expenses during your retirement years since average lifetime medical expenses from age 65+ are predicted to be $250,000/married couple.
Benefits of Using a Health Savings Account
You always want to have health insurance because you always have the risk of a serious injury, broken bone, diagnosis or emergency room visit which can cost you and your family thousands in one year. The savings that build up in this account can pay these bills when incurred.
If you are healthy now and rarely use qualified medical services, then you may be able to reduce your monthly insurance premiums using a high deductible healthcare plan and save a substantial tax deferred balance into the HSA. You can withdrawal from a newly created and funded HSA account to pay any outstanding medical bills from the past in accordance with any payment plan negotiated with the medical organization.
In addition to being able to use HSA funds to pay for health care costs incurred in the past, now and in the future, you can also receive these tax benefits:
- All contributions made to your HSA are either pretax or tax deductible, and the money within the account grows tax-free. You have until April 15 to contribute the allowed amount into your HSA for the previous year.
- When the time comes to make qualified medical expenses, the money used is tax-free, as well. Withdrawals for qualified medical expenses are exempt from federal, state, and local taxes. This can make a big difference in your taxable income depending on how much you earn and how close you are to a high tax bracket. Better than pulling money from a taxable IRA or using tax-free Roth funds to pay medical expenses.
- The Schedule A on your IRS 1040 tax form requires that medical bills must surpass 10% of your adjusted gross income before you can begin deducting medical expenses. HSA contributions and withdrawals do not have such limitations because they are not deducted on your Schedule A.
- Funds in HSAs are versatile, the money can be invested in stocks, bonds, and mutual funds to grow in value while the money is in the account.
How to Create and Contribute to an HSA
To create an HSA and make contributions, you must participate in a High Deductible Health Care Plan (HDHP) through your employer or buy your own HDHP that is “HSA eligible.” You can contribute to an HSA through your employer or directly with a provider.
Many employers offer an incentive to open an HDHP and HSA by contributing money to your HSA. This is tax-free money to you but is included in your maximum annual allowed contribution. Again, you can contribute to an HSA if you participate in an HDHP and are not enrolled in Medicare (Medicare eligibility generally begins at age 65). You can do a tax-free withdrawal from a previously created account balance at any time to cover your qualified medical expenses and insurance deductibles.
For 2023:
- You can contribute a maximum of $3,850 for an individual HSA and $7,750 for a family HSA, and if you are over age 55, you can contribute an extra $1,000 as a “catch up.”
- You have until April 15, 2024, to complete your 2023 tax-deductible contributions.
For 2024:
- You can contribute a maximum of $4,150 for an individual HSA and $8,300 for a family HSA, and if you are over age 55, you can contribute an extra $1,000 as a “catch up.”
- You have until April 15, 2025, to complete your 2024 tax-deductible contributions.
The health savings account is a tool that can help you pay for future medical expenses in the most tax-efficient way possible while reducing your current taxable income. A CFP® professional can walk you through how to create an HSA and all the financial benefits that you can reap from it. Find your CFP® professional today.