Tax Benefits of Health Savings Accounts
If you have a high deductible health insurance plan, you may be eligible for a health savings account. At first, it may sound like just another way to save money, but it has many other benefits. Knowing the tax benefits of a health savings account may convince you to take the higher deductible health insurance plan and enjoy the tax savings an HSA offers.
What is a Health Savings Account?
A health savings account is an account you set up with a bank or brokerage to save for your medical expenses. The good news is the account is tax-exempt. The bad news is you have to have a high deductible insurance plan to be eligible.
A high deductible insurance plan means you’re responsible for a larger amount of your medical bills before your insurance will kick in. This means more money out of pocket, but with the tradeoff of the tax savings, a health savings account offers.
How Does an HSA Work?
You can open a health savings account if you work for an employer that offers a high deductible insurance plan and sponsors an HSA. If not, you can open an HSA yourself, which is great if you have self-employed health insurance. Any tax breaks you can get are well worth it and the health savings account has triple tax benefits.
To qualify for an HSA, your health insurance plan must have a single deductible of $1,400+ or a family deductible of $2,800+ and be considered a high deductible insurance plan by the IRS. Your insurance provider or HR department can tell you if your plan qualifies.
If you qualify, you can contribute up to $3,600 for individual coverage and $7,200 for family coverage. This money is pre-tax, which means it lowers your taxable income for the year, saving you money while allowing you to set money aside for medical expenses.
Remember, the money you contribute to your HSA can be used only for eligible healthcare expenses including dental and vision expenses. Examples of what you can spend the money on include:
· Co-pays
· Deductibles
· Co-insurance
· Prescriptions
· OTC medications
· Feminine care products
· Acupuncture
· Medical supplies
Make sure the expenses you plan to use the funds for fall within the IRS guidelines before withdrawing funds and risking a tax liability.
The 4 Tax Benefits of a Health Savings Account
The tax benefits of a health savings account are the largest benefits you shouldn’t ignore. Here’s how you can benefit.
1. You can deduct your contributions
You can deduct the amount up to what was stated above - $3,600 for individuals and $7,200 for families. This is a direct deduction off your income, which lowers your tax liability for the year and allows your money to grow.
2. You don’t have to report employer contributions as income to the IRS
If your employer matches your contributions or contributes to your HSA, you don’t have to report the contributions as income. This means you don’t pay taxes on the income.
3. All earnings are tax-free
Any interest or dividends your account balance earns is tax-free. You don’t have to pay capital gains taxes on the funds.
4. Withdrawals are tax-free as long as they are for eligible healthcare expenses
If you use the funds for healthcare expenses as outlined in your agreement, you don’t pay taxes on the funds.
As you can see, HSA contributions are better than 401K or IRA contributions when looking at the tax benefits. With retirement funds, you either pay taxes on the money you contribute or the money you withdraw, depending on whether you opened a traditional or Roth retirement account.
The health savings account shelters your income from taxes during both the contribution and the earnings – it’s not an either/or situation.
Ways to Maximize the Tax Benefits of a Health Savings Account
Now that you know the tax benefits of a health savings account, here are ways to make the most of it.
· Contribute the maximum amount to your account each year. You don’t lose the funds – it’s not a use it or lose it situation, like an HRA (health reimbursement account).
· Treat your HSA as a long-term account rather than dipping into the funds regularly. Since you can rollover the balance each year, it’s a great way to save funds tax-free for retirement. During your senior years, you’re more likely to have higher medical expenses. If you let your contributions grow tax-free long-term, you’ll have more money available.
· Invest the money in your HSA. Too many people assume their HSA must be a cash account. It doesn’t and many brokers allow you to invest it just like you would a 401K or IRA. Take advantage of the opportunity to grow your funds even further.
Final Thoughts
If you have a high deductible insurance plan, look into your eligibility for a health savings account. It’s a great way to decrease your tax liabilities and another way to save for retirement. If you have enough funds set aside for your medical expenses during retirement, it can increase your retirement savings by decreasing the money you must spend on medical expenses.
You get the most tax benefits of a health savings account by maximizing your contributions each year. You’ll decrease your tax liability and the money you must spend out of pocket on medical expenses, whether you use it now or during retirement.
Consider funding an HSA in your name and taking advantage of the tax benefits. Whether you have self-employed health insurance or group coverage from your employer, there are ways to save money on your taxes and make medical expenses more affordable.