One of the under-appreciated aspects of inflation is its wide reach and just how many areas of finance it truly shapes, both positively and negatively. While many people associate inflation with higher rent, increased food prices, and soaring interest rates, there are other important ways inflation can affect their day-to-day living that benefit them. One of these key areas is Health Savings Accounts (HSAs).
Rising inflation costs in 2023 led to an announcement of one of the most significant jumps in HSA contribution allotment from the IRS, which will let individuals contribute even more money to their Health Savings Accounts. If you’ve been unaware of this increase news, now is an excellent time to review HSAs, why they benefit your financial and retirement planning, and how you can maximize their effectiveness to enhance your living.
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What are HSAs and How Do They Work?
I often joke that if an IRA and a Roth IRA had a baby, it would be born an HSA. A Health Savings Account (HSA) is a tax-advantaged savings account designed to help individuals and families save money for qualified medical expenses.
A qualified medical expense covers a vast array of health costs – everything from doctor’s visits to prescription medications, dental and vision care to medical supplies – which is a big reason HSAs can be so useful: you’ll save money on taxes simply by spending money on health costs the way you ordinarily would.
That said, HSAs are only available to individuals enrolled in a High Deductible Health Plan (HDHP). This is a type of insurance that typically has lower premiums but higher deductibles when compared to transitional insurance plans, so there are tradeoffs to understand and consider depending on your unique financial situation.
Eligibility Requirements
To open and contribute funds to an HSA, you must meet the following criteria:
- You are covered by an HDHP and have a deductible of at least $1,600 for single coverage or $3,200 for family coverage
- You have no other health coverage (with exceptions for dental, vision, or specific preventative care)
- You are not enrolled in Medicare
- You are not claimed as a dependent on someone else’s tax return
Contribution Limits
HSA contribution limits can, and usually do, change yearly. Given the announcement that annual limits will make one of the biggest jumps in 2024, the 2024 limits are as follows:
- Single coverage: $4,150 (a 7.8% increase from the 2023 limit of $3,850)
- Family coverage: $8,300 (a 7.1% increase from the 2023 limit of $7,750)
In addition to the yearly limits, individuals enrolled in an HSA over the age of 55 can contribute an extra $1,000 above that limit as a “catch-up” contribution. This amount remains unchanged from 2023 to 2024.
The IRS also announced raising the maximum amount employers may contribute to their employees’ HSA plans. This jumped from $1,950 in 2023 to $2,100 in 2024.
The Role HSAs Play In Financial and Retirement Planning
You may be wondering how this affects your overall financial and retirement planning? HSAs offer several valuable benefits when it comes to your financial plan, the first being your tax bill.
HSAs are triple-tax-advantaged. (Say it three times fast!) This means that your contributions are tax-deductible (lowering your taxable income), the money within the account grows tax-free, and withdrawals used for qualified medical expenses are tax-free at any time (i.e. you can use these funds whenever you need them).
In addition, unlike Flexible Spending Accounts (FSAs), HSA funds can roll over from year to year, and the account is portable, which means it will always belong to you whether you change employers or even retire.
Given these advantages, HSAs can be a powerful tool for financial planning because they let you strategically:
- Save for future medical expenses tax-free
- Build a nest egg to help cover healthcare costs during retirement
- Reduce your taxable income during the years you contribute
- Choose how and when to use the funds for a wide variety of qualified expenses
Common Misconceptions About HSAs
There are several misconceptions that people have around HSAs:
- You should use it every time you have a medical bill. The short answer is no, if at all possible. The beauty of an HSA is the tax-free investment. The longer you wait, the better it gets. And you can actually request reimbursement from HSA years after the expense was incurred.
- You should use it or lose it. Not true. If you leave your company, your HSA will rollover. Also, when you turn 65 and Medicare makes it no longer possible to contribute, that’s when you ideally start using your HSA. You’ve created an asset for medical expenses in your later years when those costs tend to increase.
- It’s just a cash savings account. This is false. HSAs can be long-term investments in stocks and bonds, and can take on more risk and less tax efficient assets.
- If my company doesn’t offer an HSA, I can’t open one. Not true. All that matters is you have the proper high deductible healthcare plan.
While I’m a big fan of the Health Savings Account and know its value, if stepping into a high deductible healthcare plan (HDHP) makes you change your medical habits of regular doctor visits (because you know you pay more until you reach the deductible), it’s not worth it. I have never talked a client into changing into a HDHP for the sake of an HSA. I just plead with the ones already in an HDHP to do it!
How to Make Your HSA More Effective
Many people use their Health Savings Accounts to manage healthcare expenses and as a valuable piece of their financial plan. But it’s essential to understand the rules and restrictions associated with HSAs and use them wisely to maximize their benefits while also complying with IRS regulations.
Here are five critical steps to making the most of your HSA for long-term effectiveness:
- Contribute the Maximum Amount: Always take advantage of the total contribution limits, especially if you have an employer that matches your contributions. Remember, this money follows you and can be used whenever needed, so it’s an excellent place to save funds.
- Invest Your HSA Funds: Most HSA plans offer the option to invest your contributions in mutual funds or other investments. Doing this can earn higher returns over time and boost your retirement savings. That said, any form of investing carries risk, so choose investment options that align with your risk tolerance and time horizon. When in doubt, always check with your financial advisor to develop an investment plan that works for you.
- Pay Current Medical Expenses Out of Pocket: Avoid using your HSA funds to cover current medical expenses. Instead, pay for these expenses out of pocket. This will allow your funds to grow tax-free and you can ultimately reimburse yourself for those expenses.
- Use HSA Funds for Retirement Healthcare Costs: HSA funds can become extremely meaningful during retirement. Whether retiring early or bridging the gap in your Medicare coverage, HSA funds can help lessen the strain on your other retirement savings.
- Coordinate with Other Retirement Accounts: HSAs work well with other retirement accounts like 401(k)s, IRAs, and Roth IRAs. Consider how your HSA fits into your overall retirement plan.
Pulling it All Together
By using a combination of disciplined contributions, savvy investment choices, and strategic use of your HSA account for qualified medical expenses, you can build a significant source of tax-advantaged income for your future healthcare needs in retirement.
To truly maximize the effectiveness of your HSA, seeking professional guidance from an Abacus financial advisor can help you create a personalized retirement strategy that incorporates your HSA effectively. Reach out to an Abacus advisor today for more information on incorporating an HSA into your overall financial plan so you can find more peace and ease around your future.
Disclosure: This material is not intended to serve as personalized tax, legal, and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Abacus Wealth Partners, LLC is not an accounting firm. Please consult with your tax professional regarding your specific tax situation when determining if any of the mentioned strategies are right for you.
