Setting aside a few dollars a month for health care expenses can save you thousands on taxes over your lifetime. The tax advantages associated with using an HSA account include:
- Tax-free contributions
- Tax-free investment growth
- Tax-free withdrawals
This triple-threat in tax savings can help HSA account owners save tons of money over their lifetime while still covering all the needed medical expenses. Learn how to properly utilize an HSA to take advantage of all the potential tax-saving offerings.
What is an HSA
HSA stands for health savings account. This unique account allows you to contribute tax-free money towards eligible medical expenses. In addition, any remaining funds in the account can be carried over from year to year and can even be invested for tax-free gains.
How Do I Qualify for an HSA?
In order to qualify for an HSA, you must be enrolled in a high-deductible health plan (HDHP). According to the U.S. Centers for Medicare and Medicaid Services, In 2022, a plan with a minimum deductible of $1,400 or more for an individual and $2,800 or more for a family qualifies as an HDHP. Note that the qualifications for an HDHP may vary from year to year.
How Much Can I Contribute to an HSA?
In 2022, you can contribute up to $3,650 for a single plan and $7,300 for a family plan. The allowable contributions change from year-to-year. Those 55 and older can contribute up to an additional $1,000 per year as catch-up contributions.
The current HSA contribution limit and qualifications for an HDHP plan can be found on the HSA’s website.
Those enrolled in an employer-sponsored HSA plan will have the funds automatically deducted from their paycheck. The employer takes care of the necessary paperwork to reap the tax benefits.
If you have an HSA of your own, you must complete form 8889 and include it when submitting your form 1040.
What Can I Use HSA Funds for?
HSA funds must be used on medical expenses for the money to be completely tax-free. However, what qualifies as a “medical expense” is surprisingly extensive. Some common uses of HSA funds include:
- Prescription costs
- Mental health treatment
- Dental care
- Vision care
Some of the more uncommon HSA allowable expenses include:
- Dental care products (toothbrush, toothpaste, etc.)
- Service animals
- Smoking cessation programs
For a complete list of allowable expenses, check out IRS Publication 502.
Can I Carryover Unspent HSA Funds?
HSA funds never expire. If you don’t spend everything you’ve contributed to an HSA in a given year, the funds continue to roll over yearly.
Once you’ve accrued at least $1,000 in your HSA account, you can start investing the funds. Gains on investments in your HSA account are tax-free as long as they are used on qualified medical expenses.
What are the Tax Benefits of an HSA?
HSAs offer several tax advantages that benefit taxpayers immediately and in retirement.
One of the biggest immediate benefits of an HSA is the ability to take a tax deduction. Any funds under the contribution limit are tax-free; it does not matter if you spend them. So as long you continue to contribute to your HSA, you get a large tax deduction every year just for putting money aside for medical expenses.
Access to Your Money Tax and Penalty Free (Sort of)
Unlike most tax-advantaged savings or investment accounts, you can access the money you set aside whenever you need it. As long as you are using your HSA funds for an eligible medical expense, you spend the money whenever you choose without having to pay taxes or penalties on that money.
The benefit of having access to your money is that you can feel confident setting aside additional funds monthly into your HSA account. Even if you lose your job or your financial circumstances change, that money is there for your medical expenses.
The only caveat is that you can’t access your money for other expenses (with one exception we will discuss later). In addition, if you need access money in your HSA for a non-qualified expense, you will need to pay a 20% penalty on top of the income taxes for the amount withdrawn.
Tax-Free Investment Growth
A huge long-term benefit of an HSA account is that any earnings you make on investments within your HSA are penalty-free if they are used to cover qualified medical expenses.
Theoretically, suppose you can cover medical expenses out of pocket and invest the money in your HSA. In that case, you could have a tax-free expense account for your later-in-life medical expenses.
You must accrue at least $1,000 to begin investing in your HSA account. Any funds past that can be added to a tax-free investment account so long as gains on those investments are only used for qualified medical expenses.
Adjust your investment strategy for this account according to your intended use of the HSA funds. For example, suppose you plan on periodically dipping into the investment account for major medical expenses or are banking on using the funds later in life. In that case, it’s better to use a conservative strategy.
Discover more ways to save money on investment income in our post on how stocks are taxed.
Access HSA Funds Penalty-Free for Any Reason After the Age of 65
If you end up going through life without needing to dip into your HSA savings, then there is some good news for you! After you turn 65, you can spend the money in your HSA savings account on non-qualified expenses penalty-free.
At 65, your HSA can function almost like a 401(k). You can withdraw money from the account for any purpose without the 20% penalty. The only downside is that you must still pay income taxes on any money withdrawn from your HSA for non-qualified expenses. The good news is that money withdrawn for qualified medical expenses is still tax-free.
HSA Tax Advantages
Still, have questions about how your HSA impacts your taxes? Maybe you’re wondering if an expense qualifies as reimbursable through your HSA? Contact us to get all of your questions regarding HSA tax advantages today!