Here's a money thing I found out about recently that blew my mind: Health Savings Accounts, AKA HSAs.
I didn't know HSAs were a thing. I didn't even know they existed until I got married and found out my husband had one. And you know what? I felt really dumb. I felt like this was a major memo that I missed. But then I realized that I had been on my parents' insurance my entire life, and there wasn't really a reason I should've just known about HSAs off the top of my head. Why should I? I was so young and carefree back then (fine, it was less than 6 months ago; stop nitpicking.).
I almost feel like I shouldn't admit that I didn't know what an HSA was, because I write about personal finance and this seems obvious. But I promised honesty, right?
I never claimed to have all the answers; only that I had all of the questions and good motivation to learn. I don't have any shame admitting I didn't know what an HSA was because I'm pretty well-read, have a college degree and do a fair amount of Googlin' my Q's. I don't have my head totally in the sand. I believe that feeling of "I should know this" is a huge barrier for people — especially women — getting involved in money decisions and investing. That's why this blog exists. To help find some of the answers, and present them in a way that is approachable and helpful to others.
Anyway, since I immediately felt like this is something I should've known, I did some digging. Here's what I found:
HSAs are the magical unicorns of retirement accounts that nobody talks about.
They're mythical. Shiny. Almost too good to be true.
What is an HSA?
Health Savings Accounts are tax-advantaged savings accounts for people who are enrolled in a high-deductible health insurance plan (HDHP). They're designed specifically for — you guessed it — qualified health expenses. I thought that the Mad FIentist explained this well:
"Since people with high-deductible health plans could face more out-of-pocket costs due to the higher deductibles, the government provides tax incentives to motivate people to save for those expenses."
And, although they aren't technically retirement accounts, HSAs can be one of the best vehicles to grow your long-term savings.
How does an HSA work?
In a way, HSAs work like a retirement account, like a 401(k), in that you can contribute pre-tax dollars and see your account grow tax free. But UNLIKE a 401(k), you can withdraw the money (for qualified expenses) WITHOUT paying taxes on them at the time that you take it out.
Related read: Is a Traditional IRA right for you?
Yep, there's an honest-to-goodness legal way to have tax-free money!
3 Reasons Why an HSA is a Legal Tax Hack:
The contributions go in tax free. (This is awesome because it lowers your taxable income.)
The money grows tax free. (This is awesome because you don't pay income tax on the interest you earn. Then your account grows even more because compound interest is the eighth wonder of the world.)
You can withdraw the money tax free when used on qualified health expenses. (This is just awesome.)
Sidebar, because this question came up at happy hour a few weeks ago: Why would you want a lower income? Answer: Lower taxes! For a very rough example, if you earn a salary of $50,000 and contribute 3,000 per year, your taxable income goes down to $47,000. Then, when the gov'ment goes to take a bite out of your money, you have a lessened starting point. 25% of $47,000 is less than 25% of $50,000. That's why you want a lower income.
How much can I contribute to an HSA?
As of 2018, individuals can contribute up to $3,450, and families can put $6,900 in an HSA. And kind of like with Roth IRAs, HSA holders who are 55 and older get to save an extra $1,000 per year, totaling $4,450 for an individual and $7,900 for a family.
And, unlike a flexible spending account, an HSA doesn't have a "use it or lose it" provision. If you don't need the money that year, it rolls over into the next year.
Like a 401(k), your contributions to your HSA can be funneled right from your employer into the account without ever being taxed — and without ever giving you the chance to spend it. And as with your 401(k), you just won't miss it if you're not used to seeing it hit your bank account.
It's like never having a spicy chicken sandwich, and not knowing what you're missing. Then one day when you really need it, a spicy chicken sandwich is dropped on your doorstep with 150 other sandwiches, and it's miraculous. I think I lost you — and me — somewhere in that metaphor, but the gist is: You won't miss it if you can't see it.
Am I a good fit for an HSA?
An HSA may NOT be for you if you consistently spend thousands of dollars every year on health expenses. In that case, it might make more sense to keep a low-deductible plan, which disqualifies you from having an HSA.
Consider your average yearly spending on medical bills and prescriptions, and determine if the maximum out-of-pocket costs would knock you over financially, should something happen and you needed to use it. Are you planning on getting pregnant soon? Know that you'll need some sort of procedure? These are things to add to the equation.
The picture-perfect candidate is relatively healthy, is already contributing to other retirement accounts and has plenty of accessible cash in case of an emergency.
But wait, isn't an HSA for medical expenses? Even hefty ones?
Yes. And you can withdraw it at the time you need and get it tax free. For most people, an HSA serves as another savings account, but one with some tax advantages that's used for medical expenses. But for those of us looking for tax hacks (hi) and increased retirement savings, the HSA becomes something even more beautiful.
So at its very worst, an HSA is a super-savvy savings account for health expenses. And at its best, it's a bonus retirement account that can lower your overall taxes and make you float with happiness.*
How HSAs function as retirement accounts:
The key phrase to remember when it comes to HSAs is this: Qualified medical expenses can be withdrawn at any time. So, if you want to use your HSA as a bonus retirement account...
Don't immediately withdraw from your HSA for health expenses.
There's no rule that says you have to take out the money at the time of your qualified medical expense, or that you have to pay it from the HSA within a certain amount of time. Essentially, as long as the qualified medical expense happened after your HSA was opened, you can withdraw money from the HSA to reimburse yourself 30 seconds or 30 years after the expense is incurred — it doesn't make a difference.
Here's an example: You go to the eye doctor and learn you need reading glasses, because you are getting older and also you stare at the blue light of a computer screen for hours on end each day. You learn that humans weren't made to look at screens for hours every day and ponder the meaning of life. The doctor interrupts your reverie and slaps you with a $300 bill for the Kate Spade frames, because you are not an animal.
You could use your HSA debit card to pay the bill. But, since you probably have $300 in your savings account, and that amount won't make or break you, you could leave that money in your HSA and let it grow. Tax free. For DECADES.
Then, sometime in 2058, when you're presumably blind as a bat but it doesn't matter because robots have replaced your need to see for yourself, you can tap into that $300. Only now, that $300 has multiplied, because you left it alone. Now, you can get that initial $300 out without paying taxes (but you do have to pay taxes on the money you take out that wasn't designated for a specific expense).
Invest it instead.
Not all HSAs are created equally, but many will allow you to invest your funds into stocks, bonds and various mutual funds — kind of like how your 401(k) is invested. And then, if you've invested it wisely, it just keeps growing. And growing. Part 2 of this post dives a little more deeply into the various ways you can invest your HSA.
Will you really need all that money one day?
Here's the thing: Can you imagine how much total money you will spend on health-related expenses over the next 40 years? As of 2015, Fidelity Investments estimated that a couple would need $245,000 post-retirement JUST for medical costs.
So if you accumulate all these costs over the years, you won't have a problem saying, "That $300 was for my glasses. But this $600 was for my prescription drugs and that $200 was for my breast pump back in the day," and on and on it goes.
THE POINT IS THIS: You WILL very likely use this money at some point for medical expenses.
What qualifies as an HSA expense?
HSA expenses are typically things like hearing aids, prescriptions, physical therapy, and things of that nature, but it can also be applied to services like psychological therapy, going to the chiropractor and more. Once you're 65 and if you are enrolled in Medicare, you can use your HSA toward your premium (but ONLY then).
Don't try to get cute.
Accidentally (or accidentally on purpose) use your HSA to pay for that new Urban Decay palette because you thought cosmetics were a core part of your emotional and physical health? Not good.
Not only do you then have to report it on your annual income tax report and pay normal taxes on it, but you'll probably get hit with a 20% penalty fee on top of that if you are under age 65. So don't try to get clever on them. Dodging taxes is clever enough to begin with.
In addition to your Sephora splurge, general purchases for overall health don’t count. Weirdly, you can't use it toward maternity clothes (rude), childcare costs for healthy babies, vitamins, over-the-counter drugs like Advil, elective cosmetic surgery, FitTea that you bought from an Instagram influencer (just a guess on that one) or a vacation. The laundry list goes on, and you should definitely check with your provider if you have an expense in question.
What happens if you genuinely don't need all that money for health costs?
The best part is that if you don’t use your HSA funds for medical expenses, you can withdraw this money to use on whatever you want — a boat, a vacation, outfits for your robot grandchildren — WITHOUT a penalty fee, once you're over age 65. Any withdrawal you make after age 65 that isn't for a medical expense WILL be taxed at your regular income tax, but there won't be any extra fees.
Health expenses & reimbursements = NO TAXES, no fees
Non-health expenses = Regular taxes, no fees after age 65
Super important stuff to remember to make the most of your HSA:
Keep tabs of your medical receipts. This is critically important, because when it comes time to ask for your tax-free reimbursements, nobody is just going to take your word for it. Get receipts. Make a digital copy. Keep a physical folder labeled "HSA - To be reimbursed when I have robot eyes" and put it in your fireproof safe where you keep your birth certificate. AND create a digital copy by the same name, because you can't be too careful.
Contribute the full maximum amount if you can. This is one of those small, incremental savings plans that you won't really miss day to day, but will blow your mind with how much it grows. Plus, it lowers your taxes. A win-win.
Send contributions straight from your paycheck. Apparently, your HSA contributions made directly from your paycheck aren't considered "wages" and therefore are exempt from FICA withholdings. That rule is a little nuanced; read thoroughly if you're interested.
Related read: Who is FICA and why does he get my money?
This is a pretty weighty post, and I decided to break it up into two chunks. In the next installment, expect to learn how to open an HSA, how to email your HR lady without feeling like a complete idiot and ways you can invest your HSA. It's going to be thrilling stuff, gang. You won't want to miss it.
Remember that I'm not a financial adviser, and I'm simply sharing what I've learned. You should consult your provider, talk to your family, and do lots of research to find the best solution for you. Until then, I'm curious: Do you already have an HSA? Is there a reason you chose a low-deductible plan instead? Is this the first you're hearing of any of this nonsense? Comment below and let me know why!
As always, thanks for reading. <3