LOOKING FOR FLEXIBILITY IN A TAX-DEFERRED ACCOUNT? YOU NEED TO SEE THIS.

As we head into the new year, thoughts turn toward end-of-year tax filing. Many people have one thought: “How can I keep more of my hard-earned paycheck?”

In earlier posts, we covered tax-saving vehicles for education, like 529 Plans and IRAs for retirement. But there’s another one involving health insurance you may not be familiar with; a Health Savings Account or HSA. They don’t often get the attention of other tax savings vehicles. But if you qualify, they can be a very flexible part of your overall tax strategy.

What is an HSA?

At its core, the HSA is simply a savings account, but the money you put into it is tax-deferred and can be used for qualifying medical expenses. We’ll review those in a bit and discuss other ways it can be used after age 65.

Who Qualifies for an HSA?

HSAs were created in 2003 as a way for all taxpayers to save for medical expenses and keep more of their earnings, but Congress balked at the thought of losing so much revenue, and a compromise was struck. Today, there are eligibility requirements to have an HSA. The most important is having a qualified High Deductible Health Plan (HDHP) and no other health insurance. You can’t be enrolled in Medicare and can’t be claimed as a dependent on someone else’s tax return. Also, you must be under age 65 before starting one. Finally, you have to meet minimum deductible limits. For 2023, those are $1,500 for an individual and $3,000 for a family.

How does it work?

An HSA works similarly to other tax-deferred accounts. Money is withdrawn from your paycheck pre-tax and placed in the account. Until age 65, it can only be used for qualified medical expenses, including deductibles, dental services, vision, co-pays, and prescriptions. Unqualified withdrawals before age 65 incur a 20% penalty. But after age 65, you can withdraw from it for any reason and only pay your regular income tax rate. Sometimes, this allows the HSA to act like a second retirement account. Also, you can invest your HSA money and let it grow. There is no penalty for not spending it, and the earnings are tax-free.

Starting an HSA early can add up. Yearly contributions in 2023 are $3,850 for self-coverage and $7,750 for a family.

Things to consider

An HSA can be a flexible part of a strategic tax plan, but there are downsides. You must be able to save enough to cover the deductible. And the tax advantage may not be significant unless your income is relatively significant. Also, the added flexibility after 65 can create the temptation to tap into it for luxury items when you may need it the most for medical expenses.

Sitting down with a fiduciary financial planner is best to learn about all the details surrounding an HSA. A good planner can also help you look at your financial situation and determine if it is a good fit for you.