Health Savings Accounts & Triple Tax Advantages: Just What the Doctor Ordered

More and more employees are using Health Savings Accounts (HSAs) as a tax-free way to save and pay for all types of future and current medical expenses, including physician visits and prescription drugs.  While the tax benefits of utilizing HSAs are generally well-known among participants, there’s also a valuable investment opportunity when saving into these types of accounts.   Since most people view HSAs as solely vehicles for health care expenses, we think investors are missing out on a great new tool to either grow their balance sheet or improve their cash flow

Already, an estimated $36 billion is held in over 20 million HSA accounts, according to HSA consultant Devenir.  One day, we could even envision HSAs to be as popular as IRAs.  So just what are HSAs? 

HSAs were introduced in 2004 following the passage of the Medicare Prescription Drug, Improvement and Modernization Act as a medical savings account available to qualified U.S. taxpayers enrolled in a high deductible healthcare plan.  At first, their use was limited due to the lack of high-deductible healthcare plans, but over 80% of large companies offer these plans today compared with less than a quarter just a decade ago. 

While growth in HSAs has been spurred on by the willingness of employees to embrace consumer-directed healthcare to keep costs in check, we like HSAs most for their TRIPLE-TAX ADVANTAGES:

  • Tax deduction – participants contribute pretax dollars (high income earners benefit the most)

  • Tax deferral – assets grow on a tax-free basis while sheltered in an HSA

  • Tax free withdrawals – if used for qualified healthcare expenses

In short, HSAs are a great auxiliary savings vehicle for the “healthy and wealthy,” and are clearly superior to other tax-advantaged savings vehicles that either tax you on the way in (Roth IRAs) or on the way out (401ks, Traditional IRAs).  As such, we recommend that individuals who have the financial wherewithal to pay for healthcare expenses out of pocket may want to leave their assets untouched to compound over time, especially since the typical couple is forecasted to spend well over $200,000 on out of pocket healthcare needs in retirement (excluding long-term care).  Post age 65, retirees can also use unused funds for non-medical purposes but must pay ordinary income rates (20% penalty if under 65); thus, in-retirement withdrawals are taxed no differently than a 401k.

For those who cannot afford to leave their pretax contributions undistributed to grow over time, HSAs offer a practical and tax advantaged way to cover medical expenses without dipping into savings or disrupting normal cash flow, all the while offering attractive portability features.  Either way, funding and utilizing HSAs is a win-win proposition!

Mike Giefer