Health Savings Accounts (HSAs) are growing in popularity as a means of saving money to cover medical expenses. They operate similarly to an IRA — you make contributions to the HSA and these contributions are partially held in reserve to cover medical expenses and partially invested to grow the account. You can use HSA funds to cover any qualified medical expenses (the complete list is in IRS Publication 502, "Medical and Dental Expenses"), or pay health expenses out-of-pocket and let the HSA account grow.
HSAs must be accompanied by a high-deductible health plan (HDHP), defined by the IRS using inflation-adjusted values. For 2015, the minimum deductible is $1,300 for singles or $2,600 for families, with a corresponding maximum out-of-pocket expense at $6,450 for singles and $12,900 for families.
Contribution limits for 2015 are $3,350 for singles and $6,650 for family coverage. (HSAs cannot be jointly owned, so even for family coverage, there is single ownership.) You can make catch-up contributions of $1,000 per year after age 55.
Advantages of HSAs over Traditional Health Insurance
- Taxes – Most people take advantage of HSAs for the "triple tax savings" – contributions to the account are tax-deductible, the invested earnings are tax-free, and withdrawals to cover qualified medical expenses are also tax-free.
- Portability – You do not have to hang on to a job you hate just for the insurance, or worry about coverage if you lose your job entirely. By disconnecting your insurance from your job, HSAs keep your insurance consistent.
- Flexibility and Control – As with an IRA, you have some control over which investments are chosen and what financial institution to use as the custodian. You also decide how to use your HSA funds — for current medical expenses up to the deductible or for future medical needs.
- Accumulation – Not only does the account grow through investment, it can be rolled over indefinitely. It does not have to be used within a specific time.
- Returns with Liquidity – The true beauty of HSAs is that they allow you a nice balance between investment-level returns on your money and the liquidity you need to cover emergency medical expenses.
There are a few institutions that allow you to invest the entire portion of the HSA without maintaining a cash buffer, but this may not be wise — if you are going to invest it all, you probably have better options than an HSA.
Most institutions set up an HSA cash account, often accompanied by a debit card, with a limit that covers all HDHP deductible situations (usually the $2,600 limit for families). Rates are sometimes tiered based on the balance to entice more funds into the liquid account (checking or savings).
Contributions in excess of that are kept in a separate HSA account for investments, with the ability to transfer funds back into the cash account readily. Keep in mind that you cannot make additional contributions to cover the losses from HSA investing. If you have to dip into the investment fund, you may have fees and other issues to deal with when liquidating your mutual funds.
Shop around for your HSA administrator. Many will limit you to their own investment products or provide incentives to invest in-house. Maintenance and trading fee structures vary widely as well — research this thoroughly to make sure your gains are not being eaten up by fees.
Once you qualify for Medicare, you can adjust the HSA for a longer-term coverage view. For example, HSAs cannot typically be used for insurance premiums, but they can be used to pay premiums for long-term care insurance — as well as long-term care costs. Once qualified for Medicare, you can use the HSA account for non-qualified expenses without penalty (although you will have to pay taxes on the withdrawal in that case).
HSAs are generally excellent choices if you are in good health, expect to reach age 65 without major health issues, and generally tend to have lower medical expenses. The rules for HSAs and HDHPs can be complex, and are subject to change in the current environment — so do your research before establishing a HSA. If you don't feel comfortable with your understanding, seek the advice of a financial professional.
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