Anytime I try to do my benefits the description isn’t helpful in explaining why it’s such a good investment move, aside from stating the obvious that it saves money incase you need it. Do I have to invest it? Or do you just let it sit? I’m confused
In: Economics
Basically, you put money into the HSA pre-tax, which lowers your taxable income. Then, you can use that money tax-free for eligible medical expenses, like doctor visits, prescriptions, and even some over-the-counter meds.
The great thing is, the money rolls over year after year, unlike some other health spending accounts and general insurance. So, it’s like a long-term savings plan for your health, with some nice tax advantages.
A health savings account is tax free. So as long as you expect to pay some sort of medical expense, including doctors visits, but also medications, medical equipment, etc., you can spend money from your HSA basically like its own debit account without ever paying taxes on it.
There’s what’s called a triple tax advantage to an HSA:
1. You don’t pay taxes on the money you put into the account.
2. You can invest the money you put in the account, and you don’t pay taxes on the profit/growth of those investments.
3. You don’t have to pay taxes on money you withdraw from the account, as long as you spend it on eligible medical expenses.
But for many people, the key is this: There is no time limit for taking money out to pay for an eligible medical expense.
So let’s say you have a $500 medical bill. You could take $500 out of the account to pay for it, sure. But if you have the money, you could pay the bill out of pocket now and leave the $500 in the account to grow tax-free for years or decades. As long as you have a record of you paying the bill out of pocket (like a receipt), you can take $500 out of the account tax-free *at any point in the future*. Thirty years’ worth of out-of-pocket medical expenses *that you would have had to pay anyway* can come back to you in tax-free payments down the road, while your money is growing the whole time. It can effectively become another tax-advantaged retirement account.
If you end up not needing the money for medical bills after all, you can withdraw money after you turn 65 and just pay ordinary income tax on it, same as you would with an IRA or 401(k). And of course if you DO encounter huge medical bills down the road, that money in the account is there for you.
It’s tax-advantaged. You can contribute to it with pre-tax income (so it doesn’t count as income towards taxes), and if you use it for medical expenses it’s not taxed on the way out, either. If you withdraw from it after retirement just for the cash, it’s taxed and acts like an IRA.
So yeah the big advantage is that if you use one and plan ahead to have this ready to pay for qualified medical expenses, it’s tax-free. And if you end up not needing it, it’s retirement money.
It’s important here that you understand what it means for money to be taken out of your income “pre tax” vs “after tax”
Say you earn $50,000 per year and your tax rate is 10% (just to keep the math simple). So you pay $5,000 in taxes. Then you have a $1,000 medical bill, so you pay that. This leaves you with $44,000 to spend on everything else in life ($50,000 – $5,000 tax – $1,000 medical bill = $44,000)
If you put $1,000 into a HSA “pre tax” that means that on your tax return it will look like you only made $49,000, and at 10% tax that means you pay $4,900 in taxes, saving $100. You then spend the $1,000 from the HSA on a medical bill. SO you have $50,000 income, less $4,900 in tax, less $1,000 in medical bills and you have $44,100 left over to spend on everything else.
Effectively by using the HSA you end up with an additional amount of money in your pocket. This can be calculated by taking the amount of money you intend to put into the HSA multiplied by your effective tax rate. Since most of us pay more than 10% tax, the actual savings are substantially larger than in the example above.
You can put money away like an IRA pre tax. Not only that, you can also invest that money into the stock market to grow.
Let’s say I’m taxed 10% on my income. If I make $5,000 in a month, I will be taxed $500. An HSA contribution is tax-free. If I contribute $500 to my HSA, my income that will be taxed will be $4500, so my tax will be $450 instead of $500. I can use that money in the HSA to pay for medical bills. I can also throw the money in the HSA into the stock market, let it grow, and withdraw it tax-free.
Tldr: contributing to an HSA lowers your taxes. The HSA can be used to pay medical expenses (that you would have paid for anyway). It can also be thrown into the stock market, grow, and be withdrawn tax-free.
Money set aside into a HSA is not taxed as income. So if you set aside $2000 into your HSA to cover medical expenses and you’re in the 22% tax bracket then you’d save $440 in taxes.
If you’re just setting aside money to spend for current year medical car you can just leave it in cash, but there are ways to invest it were you looking to save up more money for future expenses, eg. a non-covered medical procedure.
It’s actually a good alternate retirement investment vehicle. My wife and I contribute to our HSA but don’t use it to pay any health care bills at this time. It grows with pre-tax money (which means it’s about 25-30% more money than investing with after-tax dollars) and we’ll let it grow until we’re close to retirement. Then it’s available as a pool of money to be used to pay the inevitable health care costs not covered by our retirement health care plans (e.g. Medicare). If you keep good records and receipts, you can even use it to reimburse yourself for out-of-pocket costs incurred until then, so you’re paying old bills with increased funds because the HSA was invested, and getting cash out without paying taxes on it.
Note that an HSA is only available if you have a qualifying HDHP (mine meets the deductible limits, but because I have copays before my deductible limit I don’t qualify). So compare your medical plans with your medical situation, as you may be better off with a different plan that isn’t HSA-eligible (check if your employer also has an FSA).
• Traditional retirement (1.5x tax advantaged): You pay FICA tax but not income tax on contributions, money grows tax-free, you pay income tax on qualified withdrawals.
• Roth retirement (1.5x tax advantaged): You pay FICA & income tax on contributions, money grows tax-free, you pay no tax on qualified withdrawals.
• Standard brokerage account (0x tax advantaged): You pay FICA & income tax on contributions, money does not grow tax-free (dividends are taxed, and if you ever rebalance that can be taxed as well), you pay capital gains tax on realized gains.
**HSA** (3x tax advantaged if done thru payroll): You don’t pay FICA nor income tax on contributions, money grows tax-free, you pay no tax on qualified withdrawals (medical expenses).
As such, it’s even better than a 401k/IRA. It is recommended that you don’t use your HSA while you are employed unless you absolutely have to, as it’s better to keep your medical receipts and then reimburse yourself when you are retired as your portfolio most likely outpaced inflation.
To add:
• FSA (2x tax advantaged): you don’t pay FICA nor income tax on contributions, money is just held in the account, you pay no tax on qualified withdrawals. However, unissued funds are lost (given to employer) annually, though the IRS does allow a few hundred dollars to be rolled over, but your employer/provider must allow for this as well and they may also have an expiry clause against repeat rollovers. The main benefit over an HSA is that your full annual election amount is immediately available (employer/provider fronts the difference), meaning if you elected to contribute $2k/ye and on the first week you had a surprise $2k medical emergency, then the FSA can cover that and you just use the rest of the year’s payroll deductions to pay back the difference.
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