What Is An HSA? And Why Does It Belong In Your Toolbox?
There are so many types of investment accounts out there, and one gets overlooked and often times mixed up with a different employee benefit. Health Savings Accounts, or HSAs are great tools that you can use to help plan for a successful financial life. HSAs, if used correctly, are accounts that allow you to never pay income taxes on money that goes through the account.
What Is An HSA?
An HSA is an account that you have available to you to help you save for healthcare costs. With an HSA, you get to put money in before paying taxes (either through a payroll deduction or through a deduction on your taxes when you file). Once the money is in the account, it gets to grow tax free. That means that you don't pay any income taxes on the interest, dividends, or capital gains. When you make a withdrawal from the account, as long as you spend the money on healthcare-related expenses, the money is not taxed. What this means to you is that you never have to pay income tax on the money that goes through your HSA (there is no escaping all taxes...you'll likely have to pay sales tax on the healthcare goods or services you purchase).
If you are familiar with 401(k)s, 403(b)s, IRAs, Roth IRAs, or 529 plans, an HSA combines the up-front benefits of 401(k)s, 401(b)s, and 529s, with the withdrawal benefits of a Roth IRA or 529 plan.
Difference Between HSA and FSA
Many people get HSAs mixed up with FSAs. An FSA is a Flexible Spending Account and this is a tool that you can use to pay for healthcare costs, as well (there are dependent care FSAs as well, but those don't get confused with HSAs as often). With an FSA, you direct your employer to put money away before taxes and that money can be used to pay for healthcare costs. So far, it sounds very similar. However, if you don't use all the money you directed into the FSA by a predetermined time, you lose the money. If you leave your employer, FSA money does not follow you. These are accounts that are literally used to pay for healthcare expenses within the next year. These are very good if you have predictable healthcare costs, since they effectively get you a 25% discount on your healthcare (if you are in the 25% tax bracket...since you don't have to pay tax on these dollars).
An HSA, though, is your account. This account follows you wherever you go. Think of any other account that you have, like a retirement account. This is your money. You do not have to spend the money either. You can max out your HSA contributions and if you didn't go to the hospital, then that balance rolls on to next year.
Tool For Retirement
Since this is your account and you don't have to spend the money, this is a great tool for retirement. Think of it like a retirement account, but you can access the dollars early if you need to pay for medical, dental, or vision expenses. Plus, healthcare is one of the largest expenses for most of us in retirement, so it's not like we won't be able to use the money.
Some people max out their HSA and then refuse to get reimbursed for healthcare expenses because they want the money to keep growing. I don't necessarily think this is a great idea, but it goes to show you that some people are very interested in letting their money compound for a longer time period.
Asset Location
Since this is an investment account just like many other account types, you can use this as a part of your overall investment plan. It is a great idea to put tax-efficient investments in a taxable account, since these investments don't generate much for taxable income, and the taxable income they do generate is taxed at preferential rates. You will want to put tax-inefficient investments into your tax-advantaged accounts, because nothing in those accounts is taxed (neither interest, dividends, nor capital gains). So investments whose income is taxed at ordinary income tax rates would go into these accounts, as well as investments that are more likely to distribute capital gains.
Penalties and Taxes
So what happens if you don't spend this money on healthcare? Much like other tax-advantaged accounts, if you use the money for anything other than what the account is intended for you have to pay taxes and a penalty. There is one nice feature about HSAs, though, and that is once you get to age 65, then the penalty goes away for not spending the money on healthcare. You will still owe tax on the withdrawals, though, if you don't use the money on healthcare expenses. The account basically turns into an IRA (except HSAs are not subject to required minimum distributions and only the portion of your withdrawals that were not used on healthcare are subject to the tax).
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