The Health Savings Account (HSA) is one of the most powerful tools in the tax code. Is the only account where the IRS let’s you “triple dip” on tax benefits! Most accounts tax you either a) as the money is going into the account (e.g. Roth IRA), or as the money comes out (e.g. traditional IRA), however with HSA’s when used correctly, it’s the trifecta of tax avoidance!
Why HSAs are so powerful:
- Contributions are tax-deductible – Money you put into an HSA reduces taxable income (even if you don’t itemize).
- Growth is tax-free – Funds can be invested, and all growth—interest, dividends, capital gains—is never taxed.
- Withdrawals can be tax-free – As long as the money is used for qualified medical expenses, you don’t pay tax on withdrawls.
- No income limitations – Unlike some tax benefits that have income limitations that prevent high-earning tax payers from participating, the HSA has no income limit so anyone can take advantage of it
- Funds are Yours to Keep – While you may be eligible for an HSA through your employer, the funds are yours forever. So even if you leave that job you can take the account with you.
- Unused funds “rollover” every year – Unlike the Flexible Spending Account which is “use it or loose it” each year, the money you deposit in an HSA is yours forever and can be used at any time in any year
- Funds can be invested – Depending on your HSA plan, you can invest the funds in stocks, bonds, and other investments so that you can achieve a healthy investment growth on the funds while they’re in the account
Another “secret” many tax payers are not aware of is how it can be a “back-door” IRA. After age 65, if you withdraw funds for non-medical reasons, there is no penalty & the funds are simply taxed at your regular ordinary tax rate!
While HSA’s have a lot of advantages, they are not for everyone:
- To contribute, you must be enrolled in a high-deductible health plan (HDHP)
- If you have high ongoing medical costs or prefer predictable copays, this tradeoff may not make sense.
Bottom line:
If you’re eligible, don’t have high medical expenses today, and have available cash-flow the HSA is a fantastic tax strategy to take advantage of!
