HSAs Explained! The ULTIMATE Tax Loophole

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Two things are certain in life – death, and taxes. Fortunately, there are many ways around the taxes (legal loopholes) to help you avoid paying too much in taxes and protecting your livelihood.

One such way is the Health Savings Account (HSA). When done right, it offers THREE tax benefits that you should be aware of. Here’s everything you need to know to take advantage of these great tax benefits.

What is an HSA? 

HSA stands for Health Savings Account, not to be confused with the FSA, which is a Flexible Spending Account. A Health Savings Account is only for people with eligible high deductible health insurance plans.

If you are eligible, you can contribute money to your account up to the annual limit according to the IRS. In 2021, individuals can contribute up to $3,600 and families up to $7,200. If you’re 55-years or older, you can also make up to $1,000 in catch-up contributions.

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How Does an HSA Work?

You can open an HSA through your employer (if they offer it) or individually if they don’t or if you’re self-employed.

A Health Savings Account is a separate account, usually with a bank or broker. You contribute funds to it and can use the funds to pay for eligible health expenses. The sponsor will provide you with a checkbook or debit card for you to use to pay for the expenses.

Eligible expenses include copays, deductibles, and co-insurance. They may also include expenses not covered by your insurance that you must pay out-of-pocket for like prescriptions, prescription eyewear, and chiropractic treatments. HSA savings roll over each year – you don’t have to use them or lose them at the end of the year.

There is a huge caveat, though. You can use an HSA to save money throughout your entire life. If you get to retirement age, which is 59 and ½, all the money in your HSA can be spent on general living expenses. Therefore, many people use this account as a way to save extra money for retirement.

What are the Tax Benefits of an HSA?

Here’s where the real benefits start. While having money set aside for unexpected medical expenses (or even expected expenses) is nice, the tax loopholes are the best part of the Health Savings Account.

Like we said above, there are three tax benefits in HSAs:

  • Contributions are tax exempt

If you secure your HSA through your employer, your HSA contributions are pre-tax. Your employer withdraws the funds for your Health Savings Account before assessing your tax liability for the tax period. This leaves more money on your paycheck and increases your HSA balance.

If you opened a Health Savings Account yourself, you can take the deduction on your tax returns up to the maximum contribution limit for the year.

  • Your earnings grow tax-free

Whether you earn interest, dividends, or capital gains – it’s all tax-free if you leave the earnings in your HSA. So, you are contributing tax-free money and watching it grow tax-free. This alone is already an amazing benefit.

  • Lastly, your withdrawals are tax-free if you use the funds for eligible expenses

As long as you use the money for eligible health expenses, you won’t pay taxes on withdrawals.

Here’s how it works.

Let’s say you make $75,000 a year, and you have a family of 5. You contribute up to the maximum contributions of $7,200 for the year, so you are only taxed on $67,800 and you have money set aside for medical expenses to help cover the cost of your high deductible health insurance plan.

Is Everyone Eligible for an HSA?

Not everyone is eligible for a Health Savings Account. You must have an insurance plan with a high deductible AND the plan must be HSA-eligible. Your insurance provider, HR department, or employer can tell you which (if any) plans are eligible.

The government changes which plans are eligible each year, so read the fine print to make sure your plan is eligible. 

What if your employer doesn’t offer an HSA?

If your employer doesn’t offer a Health Savings Account, but you have a High Deductible Health Plan that qualifies, you can open your own Health Savings Account.

To be eligible, though, you cannot be covered by Medicare, Tricare, Medicaid, or your spouse’s insurance plan.

What to Look for in an HSA

No two Health Savings Accounts are created equal. Know what to look for so you choose the right account, just like you would any other personal finance account.

Consider the following:

  • Investment options

Think about how you want to invest your funds. Do you want an aggressive account with mutual funds or stocks, or would you rather something more conservative that only earns interest? Know what you want and compare it to your options.

  • Fees

HSAs typically have fees, but that doesn’t mean you should overpay. You’ll decrease your account balance by paying the fees, so choose an account with minimal fees and/or account balances you can meet so that you avoid the fees.

  • Access to funds

The point of a Health Savings Account is to have easy access to your funds. Know how you can access the funds and any fees you’ll incur. The most convenient access is a debit card, but you choose what works best for you.

  • Great customer service

Questions come up and problems occur, you want to work with a company you know will help you through your questions or problems quickly.

Final Thoughts – HSAs and the Tax Benefits

If you have a high deductible insurance plan or are thinking of switching to one next year, consider funding an HSA to cover your medical expenses. Since HDHPs usually have lower premiums, it may free up more money for you to put aside for your medical expenses while you enjoy the tax benefits. If you are not sure whether an HSA is right for you, reach out to your HR department talk through your option with them.  They can certainly help you make the best decision for your personal situation.

Even if you only contribute a small amount each year, any amount you contribute if you have an eligible insurance plan reduces your tax liability and grows tax-free. There aren’t too many other ways to get triple tax benefits as there are with the HSA. Take advantage and enjoy the savings despite carrying a high deductible insurance plan.

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