BLUF: The health savings account (HSA) is one of the best tax advantaged accounts that you can have. Use the tactics in this article to save big on taxes and create a money machine to fund retirement medical expenses.
Oh, it’s that time of year again. Benefits election time for all of us working those W2 jobs and for those using a variety of other healthcare sources. It felt like an appropriate time to talk about the amazing tax advantaged account that I and Mrs. MFI ignored for far too many years. I am talking about the Healthcare Savings Account (HSA)!
Yeah, not the most exciting topic on the surface. You know what is exciting? Sticking it to the tax man and keeping more of your sweet sweet money. This account can also help you retire early and worry a bit less about long term care costs. Intrigued? Read on…
What am I going to cover? Three basic areas:
- HSA Overview – All the key foundational details about HSAs: What they are, who can open one, what you can buy with them and why they’re awesome.
- HSA Basic Tactics – What are some simple ways to take advantage of that account?
- HSA Advanced Tactics – Some much more creative ways that you can use this account to your advantage over the long term.
HSA Overview
If you already have knowledge of HSA’s feel free to skim through this next section. It’s dry, but necessary because it defines the rules around these accounts. The devil is in the details!
What Is An HSA?
Right from the IRS:
A Health Savings Account (HSA) is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to qualify for an HSA.
No permission or authorization from the IRS is necessary to establish an HSA. You set up an HSA with a trustee. A qualified HSA trustee can be a bank, an insurance company, or anyone already approved by the IRS to be a trustee of individual retirement arrangements (IRAs) or Archer MSAs. The HSA can be established through a trustee that is different from your health plan provider.
https://www.irs.gov/publications/p969#en_US_2020_publink1000204023
Who Can Have An HSA?
Here are the requirements to qualify for an HSA:
- You are covered under a high deductible health plan (HDHP) on the first day of the month.
- You have no other health coverage except what is permitted (see the IRS here for details under Other Health)
- You aren’t enrolled in Medicare.
- You can’t be claimed as a dependent on someone else’s tax return from last year.
The key requirement for most is making sure that you have a HDHP. Not sure if you have one? Read here for how to tell.
Each person covered by an HDHP is allowed to have their own HSA account. Or, in a family situation, a single adult could have the family HSA and cover the expenses of the other spouse and dependents. There is no such thing as a “joint” HSA.
If you’re married and have a family plan then your spouse can have their own HSA if they’re covered by your family HDHP!
Quadruple Tax advantage
Why is this account awesome? So many tax advantages. HSA, oh how I love thee helping me stay tax free. Let me count the ways:
- Tax free going into your account if paid via a payroll deduction – No federal, state OR FICA taxes paid on the contributions.
- Reduces your taxable income – HSA contributions reduce your adjusted gross income (AGI) so you save taxes from your highest marginal tax bracket.
- Grows tax free – An HSA can be invested in stocks, bonds, ETFs and mutual funds and all growth is tax free. You can buy and sell within the account without any tax consequences.
- Tax free withdrawals for qualified medical expenses – As long as you use the HSA to pay for the IRS defined qualified medical expenses then the money comes out tax free as well.
An HSA is truly a special account.
Who Can Use The HSA Funds?
More than you might realize. Qualified medical expenses are those incurred by the following persons.
- You and your spouse.
- All dependents you claim on your tax return.
- Any person you could have claimed as a dependent on your return except that:
- The person filed a joint return;
- The person had gross income of $4,300 or more; or
- You, or your spouse if filing jointly, could be claimed as a dependent on someone else’s 2020 return.
That means that even if you have partner #1 on a HDHP and partner #2 on a traditional HCP then you can use partner #1’s HSA for expenses incurred by partner #2.
Who Can Contribute To An HSA?
Anyone currently covered by a HDHP and has an open HSA can contribute money to it up to the annual limits.
How Much Can You Contribute?
The amount that you can contribute to an HSA varies each year so be sure to check to see what the latest limits are by searching for “IRS HSA contribution limits XXXX (year)”. The information in the tables below are for people that had plans for the entire year. Review the IRS website here for information on partial year contributions.
| 2021 HSA Limits | Under Age 55 | Age 55 or Older |
|---|---|---|
| Self Coverage | $3,600 | $3,600 + $1,000 extra |
| Family | $7,200 | $7,200 + $1,000 extra per spouse over 55 |
| 2022 HSA Limits | Under Age 55 | Age 55 or Older |
|---|---|---|
| Self Coverage | $3,650 | $3,650 + $1,000 extra |
| Family | $7,300 | $7,300 + $1,000 extra per spouse over 55 |
Unlike your 401k, employer contributions to your HSA DO count towards the annual max. For example, in 2021 if a single employee had an HSA and their employer contributed $1,000 to it then the employee could only contribute $2,600 more to hit the $3,600 annual max.
How Can HSA Funds Be Used?
What is reimbursable by an HSA? There are a LOT of things actually. Here is a selection of both common and unusual items that are covered:
- Artificial Limbs
- Birth Control Pills
- Capital expenses to your home for medical care (widen doorways for a wheelchair, for example)
- Dental Treatment
- Eyeglasses
- Fertility Enhancement
- Guide dog or other service animal
- Medicare Part B,D premiums
- Menstruation Care Products
- Nursing Services
- Over the counter (OTC) drugs without the need for a prescription
- Therapy
- Transportation and Lodging to another place for the purpose of a medical procedure
Unfortunately, private health insurance premiums aren’t covered except in very narrow circumstances (COBRA). Sorry, no medical marijuana either.
Full list of qualified medical expenses here:
Be careful to not take unqualified distributions from the account before age 65. If you do those distributions are taxed as ordinary income AND subject to a 20% penalty. Ouch.
Do HSA Funds Ever Go Away?
No. To have and to hold, until death do you part. When you die your HSA will pass tax free to your spouse and they will enjoy the same tax free benefits. There are also
But what if I end up with more in my HSA account than I could possibly use? Easy, after age 65 you can withdraw money for non-healthcare expenses and it’s taxed as ordinary income.
HSA Tactics – Getting The Most Bang For Your Bucks
Now, lets talk about the fun topics. What are the different strategies that you can use to get the most of your HSA. I’ll present a variety of tactics and you can choose what best fits your situation.
I’m going to list these roughly in order from the more basic approaches and then heading to the more advanced and niche.
Use An HSA Debit Card To Pay For Expenses
Starting with the most basic approach. Save money in your HSA account in cash and whenever you have a qualifying healthcare expense, use your debit card to pay for it. The $4,928 listed below are all expenses that I paid directly from my HSA earlier in life.
It’s simple, convenient and is letting you use pre-tax dollars to pay for expenses that otherwise would be post tax. How much did that save me?
Well, our effective federal tax rate is about 15%. That means that we would have had to made about $5,800 in wages to pay for $4,928 in medical expenses net of taxes. $872 saved!
Investing With An HSA:
Saving money is great, but being FI minded we want our money to work for us. A beautiful thing about an HSA is that this isn’t just some crappy bank account where the money earns no interest. Oh no my friends, you can invest it!
You can connect the HSA to an investment account with firms like Fidelity (Mrs. MFI) or TD Ameritrade (Mr. MFI) and invest the money. It varies by HSA provider, but you generally need a minimum cash balance ($1,000 to $2,000) before they’ll allow you to start investing HSA money.
My HSA actually has two pieces: A cash account in a bank where all distributions are paid from and an investment account which are linked together but are operated by different companies. Mrs. MFI has a similar arrangement but with a different bank and investment company.
My work HSA is connected to TD Ameritrade and every paycheck it sweeps money to the TD Ameritrade invested HSA. I have the account setup to leave $1,000 (the minimum) in the HSA bank cash portion and sweep anything more into my HSA investment account.
Here are those auto sweep transactions happening every two weeks when I get paid.
That money can then be invested in whatever I choose on the platform. I’ve got the money invested in an ~80/20 split of VTI and BND. It’s a tax advantaged account so I can rebalance or change investments (sell) without any tax consequences.
Quarterly I’ll go in and make a purchase with the cash that’s accumulated. Looks like I’ve been slacking and have $1,280 accumulated that needs investing.
Clearly this year has been incredible unusual as far as US stock growth. YTD this basic invested HSA is up almost 50% or $6,000. Far more than I’m allowed to contribute to the account in a single year.
Vanguard for some reason has decided to stay out of this HSA market for the time being.
HSA Advanced Tactics
Now, for some fun stuff. How can you actually take the use of this fancy HSA to the next level and stack these benefits? Let’s explore that. I love nothing more than to find legitimate ways to game the system. Some of these ideas you can stack and use together.
Pay For Medical Expenses With A Cash Back Credit Card
A key thing to understand about an HSA is that you can reimburse yourself tax free from that account, regardless of how you pay for the medical bill.
Knowing that, why would you ever use an HSA debit card to pay for a medical expense? I’m a huge fan of credit card rewards so I put as much as possible on my cards. I use the Citi DoubleCash credit card for 2% cash back on everything. If you spend $3,000 a year on medical bills that’s still $60 cash back for nothing.
Then you can submit to your HSA provider for reimbursement of that expense from your account. Here’s a key point. Your HSA provider isn’t necessarily going to check that what you’re submitting for is a legitimate expense. The IRS is the one that may come knocking and ask for proof that these were legitimate expenses.
For that reason, it’s important that you keep sufficient proof that the bill that was paid by your HSA was for a qualified medical expenses. Here’s what the IRS says you need to keep for records:
How should you keep these records? I’m a big fan of Google Drive. I recommend keeping a copy of record which has the details of the service, proof that you paid the bill and when it was paid.
Use Medical Expenses To Hit A Credit Card Sign Up Bonus
If you’ve read the blog then you know I’m a fan of credit cards for travel rewards. A key part of travel rewards is to open a card with a great sign up bonus (SUB) that’s paid when you hit a minimum spending level.
No better way to hit a minimum spending level than to charge medical bills to a new credit card. Then you can use your HSA to pay yourself back. Medical bills are a pretty good candidate for this since there’s a big lag between the service and the bill arriving. Plenty of time to apply and get a new card. The bigger risk might actually be that they take TOO long to bill you.
One thing to be aware of is that if you pay a bill with a credit card then you give up your ability to negotiate down a larger bill. So, make sure that you do that first before paying the bill.
Take a medical tourism trip and partially reimburse yourself with your HSA.
This one seems like cheating but it’s in the rules. If you have a trip that you’re taking for medical tourism purposes then you can pay for transportation and some of your lodging with your HSA. By that I mean that you’re traveling to another location for the main purpose of having a medical procedure done.
Mexico is popular for very cheap dental care so if you had an expensive surgery this would be a great option. Take the trip, save a lot on the procedure, pay for it all on your favorite credit card. Then reimburse yourself for part of the trip and the surgery with your HSA. How sweet is that?
Pay For Medical Expenses Out Of Pocket, Let Your HSA Grow
Up until now we’ve been talking about paying for your medical expenses out of the HSA because it’s all tax free. The next idea might seem counter intuitive but you could pay for medical expenses out of pocket and NOT reimburse yourself from your HSA right away.
Why might you do that? The power of compounding. If you constantly spend the money that you contribute to the HSA then that money never gets a chance to compound. However, suppose that you let those HSA contributions grow to $50,000. By the 4% you could withdraw $2,000 a year and have a high likelihood of not running out of money over 30 years.
A Secret Emergency Fund
Here’s another trick. If you pay for medical expenses out of pocket you can reimburse yourself anytime in the future from your HSA. For example, I spent $3k this year on medical expenses (not my best year) but paid out of pocket.
I have those receipts and 10, 20 or 30 years from now I can use those receipts and pay myself back that $3k. It’s like having a special investment account that I can draw on anytime in the future when I need it. I love safety nets.
Long Term Care Self Insurance
One concern of many is the cost of long term care in our later years. It’s understandable as nursing homes can cost $100,000+ a year.
What if you saved diligently, didn’t spend that HSA and then let compounding do it’s thing? Say that a couple is able to save $100,000 in an HSA by the time they’re 50 years old and never contribute another dime. They pay out of pocket for expenses to do that.
If that $100,000 grows by 7% annually then when they hit 80 years old the accounts will be have $811,000! That’s a healthy balance to handle your long term care.
What if you don’t need that much money? Well, after age 65 you can withdraw HSA money penalty free and it’s taxed as ordinary income. Problem solved. Did I mention that it’s not subject to required minimum distributions (RMDs) either?
Use It To Cover Insurance Premiums
Maybe you aren’t worried about long term care but you are worried about other medical expenses in retirement. You can’t use an HSA for private healthcare insurance but you CAN use it for Medicare part B and D insurance after age 65.
Below are insurance options that DO qualify for HSA reimbursement. As always, these change over time so consult the IRS website for the latest rules.
- Long-term care insurance.
- Health care continuation coverage (such as coverage under COBRA).
- Health care coverage while receiving unemployment compensation under federal or state law.
- Medicare and other health care coverage if you were 65 or older (other than premiums for a Medicare supplemental policy, such as Medigap).
Action Steps:
- If you have a HDHP and don’t have an HSA, open one!
- Setup your account to contribute to it every paycheck. Even if it’s $10 a paycheck, get started.
- Look into how much you need in your HSA to start investing.
- Once you have enough to start investing, open an HSA investment account. Fidelity is one of the top providers.
- Setup your HSA to autosweep funds to your investment account.
- If available, setup your investment account to auto-invest the proceeds.
Additional Resources:
- IRS HSA info: https://www.irs.gov/publications/p969
- List of qualified medical expenses https://www.irs.gov/publications/p969#en_US_2020_publink1000204083
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