Are You Making the Most of Your Health Savings Account?

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There will no doubt be changes in the healthcare landscape in the coming months and years. But experts are in agreement about this: Health Savings Accounts, which predate the Affordable Care Act by a good half-decade, aren’t going anywhere. Today, the high-deductible health plans that make policyholders eligible to open a health savings account represent about 20 percent of the health insurance marketplace, according to the Kaiser Family Foundation.

And that share will likely climb higher in the coming years, particularly if contribution limits go up and plan design requirements are relaxed.

That’s why it’s important to learn, as soon as possible, how to make the most of these accounts. Unfortunately, that’s something many participants aren’t doing right now, says Paul Fronstin, director of the Health Research and Education Program at the Employee Benefits Research Institute (EBRI).

That’s partly due to simple confusion: HSAs sound a lot like FSAs (flexible spending accounts), but apart from the fact that both allow you to pay for medical expenses with pre-tax dollars, they have big differences. The biggest: If you don’t use the money in your FSA before the deadline, you may lose it, while HSA dollars are yours to keep and use as you choose. They’re even portable if you change jobs. In fact, Fronstin calls these accounts “the best thing out there, from a tax perspective.”

If you’re eligible for one, here’s what you need to do:

Open an Account

It sounds like a no-brainer, but in fact, many people who are eligible to open HSAs don’t do so. According to a 2016 EBRI report, there are 20 to 22 million HSA-eligible policies in place, but only 18.2 million open accounts, according to Devenir Research.

That means that between two and four million people have HSA-eligible health insurance policies, but failed to actually open the account.

That’s a problem, because you’re supposed to open an account before you incur medical expenses for which you want to be reimbursed, explains Dr. Steve Neeleman, founder and vice chair of HSA provider HealthEquity. You don’t have to have all the money in there to pay the claim before you incur it, however. So you can open the account and fund it with $1 (or whatever the minimum balance happens to be), and add more money as you need it

Make a Contribution  

According to Devenir, 20 percent of HSAs were unfunded as of mid-2016. That’s unfortunate, as there are significant benefits to contributing. First, there’s a tax-deduction on contributions of up to $3,400 (for singles) and $6,750 (for families) for 2017, and people 55 and over can contribute an extra $1,000. The money can be used to pay for non-reimbursed medical expenses (including many you may not expect, like travel to receive medical care). Depending on your tax bracket, that is akin to shaving 25 percent or more off your medical costs!

While the money is in the account, it can grow tax-free just like money in a retirement account or college savings plan (more on that in a moment).

And when you withdraw the money to use for eligible medical expenses, you won’t pay any taxes.

(If you’re withdrawing money to use on non-medical expenses, you’ll pay ordinary income tax at your current rate; there’s also a 20 percent penalty for non-medical withdrawals, though after age 65 that penalty vanishes.)

As an additional benefit, many employers are now offering to contribute to your HSA as an incentive to get their employees to take a high deductible health plan; those contributions are usually in the $500 to $1,000 range, though some employers are even more generous.

Strategize About Where to Put Your Next Dollar

When you’re deciding where to put your savings, HSAs not only belong squarely in the mix, they belong near the top of the list. Start by comparing employer incentives — that is, what do you have to do to get the HSA incentive?

In some cases, all you have to do is open the account, which means this is effectively free money!

Next, fund your 401(k) to the level required to grab that employer match. Finally, come back and flesh out your HSA contribution to get the full tax deduction, before moving back to your 401(k). After both are funded to your satisfaction, move onto other retirement savings vehicles, college savings accounts, and savings accounts tied to other goals.

Turn on the Investment Option

Many (though not all) HSA providers offer you the option to invest the money you have in the account, much like you do in your retirement account. You may need to accumulate a certain amount of money before you’re able to do this. At SelectAccount, for example, once you’ve contributed $1,000, you can invest the money in any of eleven designated no-load mutual funds; once you’ve amassed $10,000, you can open a self-directed brokerage account at Charles Schwab, which opens the door to 2,500 mutual funds, as well as stocks, bonds and other investments.

But you have to flip the switch. And according to Fronstin, only 4 percent of accounts have investments other than cash. Again, that represents a missed opportunity. Devenir Research reports that the average total balance of an HSA investment account is over $15,000 — nearly 8 times the balance of a non-investment account.

Figure Out How You’re Going to Use the Money

As long as you’ve got an HSA in place, there’s a lot of flexibility when it comes to both funding and using it. Just as with an IRA, you’re given up to the tax deadline of the following year to make your contribution for the prior year. That means you can still make contributions for 2016 until April 15, 2017. (Contribution limits were $3,350 for singles and $6,750 for families.) After you contribute, you can then reimburse yourself for money you spent on healthcare last year.

Of course, you’ll need receipts noting where that money went, but as Fronstin notes, “if you’re not in a position to contribute to the account and pay medical expenses, this at least gets you the tax break.”  But it’s also important to note there is no expiration date on reimbursements. That means you can invest the money in the account — allowing it to grow in the market — while paying for today’s health care expenses out-of-pocket. All the while, you can keep a running tally of what you’re spending on healthcare, then at some point in the future pay yourself back for all of the money you’ve spent in the past — using money that’s had time to appreciate.

Think in Terms of a Lifecycle

If you’ve been hesitant to dive fully into the HSA pool because there’s already so much pressure to save for retirement, college, and other goals, it may help to think about it over the course of many years rather than one-by-one. When you’re young and have relatively few responsibilities (perhaps you’re even one of the fortunate few with no student loans), consider this an opportunity to heavy up your contributions. As you get older, and have children who catch mono or break limbs, you may need to contribute less and access the money more. Then, as those kids leave home, you can increase the flow of money into the account once again.