Open enrollment season for employer benefits is upon us, and once again we are all being asked to make a big batch of decisions that will impact our welfare in the coming year (and our long-term prospects as well).
As you gaze into your crystal ball and try to predict your needs over the next 12 months, allow me to put a bug in your ear about a little-known but highly valuable wealth-building tool that you may want to include in your upcoming benefit elections.
What Is an HSA?
HSA stands for Health Savings Account. This type of account is relatively new. Created in 2003, it is designed to give individuals covered by a high-deductible health plan tax-preferred treatment on money set aside for medical expenses.
When an individual enrolls in a high-deductible health plan, they become eligible to put money into an HSA.
For tax year 2021, an individual may contribute up to $3,600 to an HSA. If your family is covered by the high-deductible health plan, the contribution limit goes up to $7,200.
If you are 55 or older, you can contribute an additional $1,000 in a given year.
Like contributions to your 401(k), HSA contributions are shielded from ordinary income tax.
Unlike your 401(k) contributions, they are also shielded from employment taxes. You also have the option to invest the funds in your HSA (more on this later), and any gains are tax-deferred (again, much like your 401(k)).
In addition, funds drawn down from the account, regardless of your age, are tax-free as long as they are used for qualified medical expenses.
Why I Love HSAs
There are three things I really love about HSAs:
- You get tax goodies today (no income tax or employment taxes on contributions) and tax goodies over the life of the account (tax-deferred gains and no tax on withdrawals for qualified medical expenses).
- Unlike other tax-advantaged savings tools like 401(k)s and IRAs, HSAs are liquid today. You can put money in and take it back out any time as long as you are tapping those funds for qualified medical expenses.
- These accounts incentivize you to save for something you will definitely need to pay for in the future.
How an HSA Fits In
Think of an HSA as a dual-purpose tool that you can use differently during different stages of your financial life.
If you are at a stage where you are just starting to save and invest but aren’t yet maximizing contributions to your employer-sponsored retirement plan and IRA, the HSA is a good tool for funding your annual medical expenses in a tax-advantaged manner.
During this year’s open enrollment, if an HSA is available to you, look back on last year.
- How many doctor visits did you have?
- What were your prescription drug costs?
- Did you see a non-MD like a chiropractor or acupuncturist regularly?
- Will you need new glasses and/or contacts?
- Are you anticipating any major expenses like dental work, surgery, or pregnancy?
Now using the information from your health insurance plan around co-pays, co-insurance, and out-of-network care, see what your cost could be for these anticipated needs. If you like, gross that amount up by 10% or 20% just to be safe.
This number is the amount you’ll want to defer to your HSA for the coming year.
By doing this, you should be able to cover most or all your out-of-pocket medical costs tax-free.
In this case, leave your HSA funds in cash since you plan to spend them in the coming year.
If you are at a stage of life where you’ve got sufficient cash flow to fully fund your employer-sponsored retirement plan and your IRA, as well as cover your out-of-pocket medical expenses, you can start viewing your HSA as another wealth-building tool.
How an HSA Builds Wealth
Here's the secret sauce: You can invest the funds in your HSA like you would in your 401(k) or IRA!
That means you can take pre-tax money, invest it, get tax-deferral on all your gains, and then spend that money on qualified medical expenses (now or in retirement) and pay zero taxes on your withdrawals.
When used carefully, an HSA can help you build wealth that is tax-free.
A note of caution: The HSA is first and foremost an account meant to help you cover out-of-pocket medical expenses. Make sure you leave enough of your HSA in cash to cover those costs for the coming 12 months, so you aren’t caught short.
Finally, choose your investments wisely. An HSA is not the place to speculate. In fact, you may wish to own investments that are less risky than those you own in your retirement and other investing accounts.
Is an HSA Right for You?
If you’ve read enough of my writing, you’ll know that the answer (as with many financial decisions) is: It depends.
Before enrolling in a high-deductible health insurance plan to gain access to an HSA, make sure such a plan is suitable for you and your family.
If you have chronic conditions and need frequent doctor visits, have several prescriptions, and/or anticipate a major medical event like a pregnancy, such a plan may end up draining your wealth rather than building it up.
You’ll also want to be sure you can afford to set aside money from each paycheck to fund your HSA and can afford to wait until you need care to tap those funds.
It is worth noting here that some employers offer to contribute to the HSAs of employees who enroll in high-deductible health plans. Check to see what your employer’s policy is and factor this potentially free money into your calculations.
Finally, if you decide an HSA is right for you, coordinate funding of it with your other tax-deferred savings options, like your employer-sponsored plan(s) and your IRA in order to maximize your total benefit.
For the thoughtful and prepared, the HSA offers an excellent opportunity for wealth building.
 If your employer offers HSA contributions, your own contributions, plus employer contributions can total only up to the $3,600 limit ($7,200 in the case of family coverage).
 These typically include co-pays, co-insurance, prescription drugs, vision care, and most dental care. See https://www.irs.gov/publications/p969 for details.
 Remember the contribution limit.