Health Savings Accounts (HSAs): The Holy Grail of Investment Accounts?

health savings accounts

Preparing for Medical Costs – In Your 20s, 40s, and 60s

In our most recent blog on Medicare, we dive into the many healthcare options that people face around the age of 65. It can be an overwhelming experience as each individual has different needs and has to shuffle through and analyze coverage options, deadlines, penalties, and enrollment periods. We know for some, 65 may feel like a long way off, but that does not mean you shouldn’t be planning for those anticipated medical expenses in the nearer term. Thankfully, Health Savings Accounts were created that can help prepare for rising healthcare costs (including Medicare) decades in advance!

Health Savings Accounts (HSAs)

In 2003, the Medicare Prescription Drug and Modernization Act created the Health Savings Account. The HSA was established so that individuals and families could pair their high-deductible health insurance policy with a tax-advantaged savings account. These accounts allow individuals and families to reduce premium payments and put the savings into a plan that could assist with future medical expenses.

If used properly, qualified contributions to the account are tax-deductible, while distributions for qualified medical expenses are completely tax-free (before age 65, you will be hit with a 20% penalty and income taxes on funds used for non-qualified expenses). Given its tax-advantaged nature, HSAs have the potential to be the “holy grail” of investment accounts, providing a tax-deduction on the front-end, tax-deferred growth on the earnings, and tax-free withdrawals when used on qualified expenses.

Qualification

If covered by a medical plan, there are a few policy requirements that need to be in place to gain access to a Health Savings Account. First, the policy must be considered a high deductible health plan. By 2021 standards this includes at a minimum a $1,400 deductible on the individual level and $2,800 for the family. In addition, the plan must have maximum out-of-pocket amounts that do not exceed $7,000 and $14,000, respectively.

Contribution Limits

Before Age 65

Like other tax-advantaged accounts, HSAs also include contribution limits. These are at the individual and family level and are inclusive of employer and employee contributions. In 2021 the maximum contribution for an individual is $3,600 and $7,200 for families. For those age 55 or older, catch-up provisions are provided, which allow an additional contribution of $1,000 per year.

Interestingly, if both spouses are age 55 or older and each has their own high deductible health plan, then both can make catch-up contributions ($1,000 to each of their plans). This means a family’s contribution limit may be able to reach $9,200 ($7,200 family limit plus two $1,000 catch-up provisions). Although catch-up amounts have not grown in over a decade, the minimum deductible, maximum out-of-pocket expenses, and contribution limits have grown to keep up with inflation.

After Age 65

Once an individual reaches age 65 (Medicare eligibility) contributions can no longer be made to a Health Savings Account. However, at age 65 the HSA has reached a transition phase where it can be treated like a traditional IRA for withdrawal purposes. Before 65, distributions for non-qualified expenses are taxed as income and hit with an additional 20% penalty. However, once 65, HSA distributions can be used on non-qualified expenses without penalty (income taxes still apply).

Using an HSA as a Tool for Retirement

Short Term vs. Long Term Benefits

Given the increase in health care expenses over recent decades, we find that HSAs offer a great opportunity to help mitigate those costs in the future. Many investors put money into their HSA to get the initial tax deduction but may leave it in cash or use it on current medical expenses. By doing so, they could be missing out on years of tax-deferred growth and foregoing the one account in their portfolio that offers the potential of three tax-advantaged features mentioned above.

It can be tempting to use the money in your HSA in the near term if you have a tangible need, but keep in mind that as you age there is a higher likelihood of your medical care needs increasing. Pairing that with increasing life expectancies (due to improved medical care), it may be prudent to consider how you can plan for that season of life now.

Due to the likelihood of future needs and the tax-advantaged nature of the account, Kings Path often puts the HSA near the top of the list for saving purposes. Typically, we encourage investors who participate in a company matching program to take full advantage of that benefit (It is hard to beat a 50% or 100% “return” on your matched investment!). However, once the match has been exhausted, maxing out an HSA(s) is often the next priority. And then, if they have the cash flow to afford to save more, they can go back to their qualified plan or potentially a traditional or Roth IRA.

Best Savings Strategies

  1. Company Match – “free” money

  2. HSA – Triple Tax-Advantaged

  3. Company Plan, Traditional IRA, or Roth IRA

Getting Set Up

Setting up an HSA is typically an easy task. This can be done through employer-provided Health Savings Accounts or third-party firms (e.g. Fidelity). Oftentimes, the plan administrator and investment platform are different parties, so it may take a little searching to get your investments started. Some plans require a minimum cash balance for medical expenditures, which can cause a cash drag on accounts that are just getting started. These minimums become less of a concern as the account grows through earnings and contributions. In addition, investment options can vary across platforms and providers. Be aware of fees within the plan and those associated with each fund option.

What Happens to My HSA When I Die?

HSAs can be a helpful tax tool for you and your spouse, but the account loses some of its luster if passed to a non-spouse beneficiary.

If the beneficiary is a spouse, it transfers ownership free of probate and the spouse can use the HSA tax-free (on qualified expenses) for the remainder of their life. Essentially, it becomes the spouse’s HSA and is subject to tax and penalties in accordance with their age and distribution purposes.

If the beneficiary is a non-spouse (e.g. child, grandchild, or friend), the account is taxed within that year and turned into a regular taxable account under the beneficiary’s ownership. Unlike IRAs, which include a 10-year stretch provision to non-spouse beneficiaries, HSAs are not as friendly. In the event a large HSA is passed to a non-spouse, this could result in a very large tax bill to the inheritor! For most people, this serves as an encouragement to name their spouse as the primary beneficiary.

Another option, given the unkind tax treatment to non-spouse beneficiaries, is to gift your HSA to charity directly and utilize other assets to pass on to the next generation. HSAs do not allow for annual qualified charitable distributions like IRAs (at particular age requirements), but these assets can be passed to a charity tax-free at death.

Conclusion

Health Savings Accounts can serve as a helpful savings tool for anticipated medical expenses later in life. Their tax-advantaged nature allows for benefits that can assist both now and much later in the future. However, depending on your estate and legacy goals, it is prudent to come up with a proper plan for building the account over time. Additionally, you should design a distribution strategy that considers tax implications for you, your spouse, and the next generation.

Contact us to learn more.

Kanen Helbig, CFA® CFP®

Kanen passionately serves as Vice President of Kings Path Partners. In this role, he provides families and institutions customized and well-designed investment and financial planning solutions. Kanen assists the team with the development of company benchmarks, risk models, and client portfolios. Additionally, Kanen serves clients by providing reporting, performance and cash flow analysis, financial modeling and goals-based planning. Kanen is devoted to helping clients utilize their resources optimally and with purpose, understanding that we are stewards of our time and possessions.

While attending Texas A&M University Kanen received his Bachelor of Business Administration in Finance, graduating magna cum laude. Kanen is a CFA® charterholder and a CERTIFIED FINANCIAL PLANNER™ professional who enjoys partnering with clients to develop their financial journey in hopes of meeting their goals.

Send an email to Kanen

Kings Path Partners, LLC (KPP) is an SEC-registered investment advisory business based in Sugar Land, Texas. KPP has published this article for informational purposes only. To the best of our knowledge, the material included in this article was gathered from sources KPP believes to be accurate and reliable. That noted, KPP cannot guarantee that this information is accurate and complete and cannot be held liable for any errors or omissions. Readers have the responsibility to independently confirm the information herein. KPP does not accept any liability for any loss or damage whatsoever caused in reliance upon such information. KPP provides this information with the understanding that it is not engaged in rendering legal, accounting, or tax services. In particular, none of this published material should be considered advice tailored to the needs of any specific investor. KPP recommends that all investors seek out the services of competent professionals in any of the aforementioned areas. With respect to the description of any investment strategies, simulations, or investment recommendations, KPP cannot provide any assurances that they will perform as expected and as described in this article. Past performance is not indicative of future results. Every investment program has the potential for loss as well as gain.

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