Get the most from your HSA
What is a Health Savings Account (HSA)?
A Health Savings Account (HSA) is a tax advantaged medical savings account available to taxpayers in the United States enrolled in a high deductible health plan (HDHP). Money contributed to this account is designated for medical spending, to be used on qualified medical expenses. These contributions are tax advantaged as they are not subject to federal income tax (they are tax deductible), so you get more bang for your buck. HSA's are a smart, tax reducing way to help consumers pay for medical care.
Characteristics of Health Savings Accounts:
- Must have a qualified health insurance plan (HDHP) to open an HSA
- Acts as a separate bank account in your name
- Withdrawals must be spent on medical purhases (qualified medical expenses)
- You own the money forever, regardless of employer; no "use it or lose it"
- You don't pay tax on HSA contributions
- After age 65 you may use your HSA however you like, tax free
- Can invest your HSA in stocks, bonds, ETF's, and other instruments
Basically, it is your own tax advantaged savings account designated for medical purposes. Instead of paying for medical care with dollars that have been taxed, you pay with pretax dollars which effectively gives you a discount on medical expenses equal to your tax rate. The money you contribute remains yours forever, even if you change insurance plans to a non-HDHP account.
Required Record Keeping for Health Savings Accounts
In order to reap the benefits of an HSA, you have to do a tiny bit of work to satisfy the IRS. The key is to keep all transactions that affect your HSA up to date, and that is what TrackHSA helps you accomplish. At the end of the day, at tax time you need to:
- Know how much you contributed to your HSA that year
- Know how much you withdrew from your HSA that year
- Justify to the IRS that those withdrawals were for qualified medical expenses
In allowing you to use tax free money for medical expenses, the IRS requires that you be able to prove that any spending from your HSA was actually for qualified medical expenses. This prevents people from taking advantage of the system. TrackHSA helps you do this in three ways:
Categorize Purchases
When you record an HSA transaction, you can describe the purchase using the HSA Category field. It contains a summarized list of qualified HSA medical expenses per the IRS. Classifying your purchase using one of the options validates that your use of HSA funds is appropriate and qualified.
Upload a Receipt
This is a critical step. By uploading a copy of the receipt from your HSA purchase, you maintain proof that you purchased a qualified medical expense for a given dollar amount. Doing so proves your HSA purchase and audit proofs you should the IRS come knocking.
Track Reimbursements
Not all of your HSA spending will be initally paid by your Health Savings Account. You might instead use cash, check, credit or debit card at the point of sale. In these cases where the purchase was for a qualified medical expense, you are allowed to reimburse yourself to effectively pay for the service with pre-tax HSA dollars. This occurs by simply transferring funds from your HSA to another account owned by you for the amount of the medical expense. TrackHSA clearly shows you what purchases are due for reimbursement using green text. Once you decide to reimburse yourself, simply update that transaction to reflect that reimbursement has occured. You can even add a note to include the details. Knowing which purchases have not been reimbursed prevents you from overpaying taxes and allows for Advanced HSA Strategies, below.
Paying Lower Taxes with an HSA
Health Savings Accounts lower your taxable income for a given year, since all HSA contributions are not taxed. This mechanism can occur in two ways. If you contribute through your employer, contributions are deducted from your paycheck before taxes are applied, so they avoid being taxed. Alternatively, if you make manual contributions to your HSA (like most people), you contribute taxed dollars but you remove these contributions from your taxable income when you file your taxes. This lowers the amount of tax you pay, sometimes by means of a refund.
Of course, paying less taxes is good:
For example, the maximum HSA contribution (single) for 2016 is $3,350. Suppose you have a tax rate of 25%. Without an HSA, that $3,350 is earned and taxed as normal income at 25%, so you pay $838 in taxes with the remaining $2,512 going to your bank account.
Using an HSA, you shelter this $3,350 so that you keep 100% of it. Instead of having $2,512, you can have the entire $3,350 in your HSA account to use for medical expenses or retirement. You can even invest that account to grow it over time.
Advanced Strategies
Here are a few of the advanced strategies that TrackHSA can help you employ to get the most out of your HSA. For more discussion around advanced HSA strategies check out my blog HSAedge.com.
Save on Medical Costs
This is the main benefit that everyone receives by paying for medical services with their HSA. As discussed above, not paying taxes on your HSA contributions means there are more dollars in your account, so medical costs are cheaper roughly by your tax rate (e.g. 25% discount). This savings adds up year after year, and as you'll see below, any funds in your HSA at age 65 can be withdrawn penalty free (i.e. retirement).
Reduce your Taxable Income
Contributing to your HSA de facto reduces the amount of taxes you will pay in a given year. If you are earning $75k with no HSA, you are paying tax on the full $75k. However, if you have an qualified HDHP you can open an HSA, contribute $3,350, and only pay taxes on $71,650 of income, resulting in a smaller tax burden. You keep more money and pay less taxes. Your HSA contribution will certainly come in useful, as you use it for future medical expenses or even retirement. Best of all, it can be invested along the way so it can grow and compound year over year.
Create a Rainy Day Fund
HSA qualified purchases do not need to be initially paid with your actual HSA account. You can pay for care with your regular credit card and reimburse yourself later from your HSA, a transfer which effectively pays for the service with your HSA (e.g. tax free dollars). However, delaying this reimbursement is a powerful strategy that can provide you flexibility. Having a reimbursement due (green dollar text in TrackHSA) means you are due for reimbursement, so you can pull this money from your HSA at any time. Should you need it, you have this cash at your disposal. Your HSA acts as a source of funds, where you can withdraw from it at any time to reimburse yourself for prior qualified purchases not-yet-reimbursed. You can then use this money for whatever you want, a large purchase, expense, or investment. Doing so gives you flexibility and access to capital.
Tax Free Investment
Following the prior example, while you can reimburse prior purchases at any time, you can choose to keep those dollars in your HSA. Why would you want to keep that money unreimbursed in your HSA? The answer is if you are investing all or part of your HSA balance, that money is growing, tax free. If you take a long term approach, it is better to let that untouched, tax-free capital grow and compound over the years than to pull it out to pay for a medical transaction, nipping that growth in the bud. Of course this is not always possible, but the advanced strategy is to "protect" that tax free capital (equal to your HSA contribution), invest it, and let it grow. That will pay dividends down the line as the law of compounding does its magic.
Save for Retirement
While HSA's are primarily medical savings accounts, they are treated like Individual Retirement Accounts according to the IRS. At age 65, you can use your HSA for anything (including non-medical expenses) penalty free. This means that you can go years saving in your HSA, using it for qualified medical expenses as needed, and when you turn 65, repurpose those HSA funds for whatever you like. Like non-qualified withdrawals, you will need to pay tax on distributions (since you never paid income tax on the money), but all of those earnings from investment grew tax free. This is similar to how an IRA works - either you pay tax up front and contribute (Roth), or contribute and pay tax on withdrawal (traditional IRA).