You're not using your HSA the way you should

The Savings Game

Health savings accounts are an attractive and often underappreciated retirement tool for many Americans.

Every year, more people become eligible for an HSA when they enroll in a high-deductible health insurance plan. Employers promote this type of coverage as a way to shift the cost burden to employees. Lower premiums are a key incentive, and HSA funds can be rolled over every year.

HSAs are tax-advantaged much in the way that IRAs and 401(k)s are. Funds contributed to the account are tax deductible and grow untaxed. Withdrawals are not taxed if used to pay for qualified medical expenses.

To be eligible, the minimum annual insurance deductible for 2017 is $1,300 for individuals and $2,600 for families; the maximum deductible is $6,500 for individuals and $13,100 for families. (See IRS Publication 969.)

It’s a good deal, and Congress seems intent to expand the role of HSAs.

Nevertheless, HSAs are not being used to their maximum advantage. Many who are eligible and who should use this vehicle have not established an account. And most individuals who have HSAs use the funds they’ve contributed to cover their yearly medical expenses. This is not required, and not always the most cost-effective way to use HSAs.

You should look at HSAs the way you look at the advantages of IRAs, Roth IRAs and 401(k)s. Holders of these retirement accounts rightly try to avoid making withdrawals until it is absolutely necessary in order to allow the accounts to increase in value because all interest, dividends and capital gains grow tax deferred.

If you make maximum contributions to your HSA and withdraw as little as possible, the account will increase in value — tax deferred — the same way your retirement accounts grow. In some ways, the HSA is more advantageous.

For example, if you make an IRA or 401(k) withdrawal, the withdrawal is taxable. Withdrawals from your HSA are not taxable if used for medical expenses. With Roth IRAs, contributions are made with after-tax funds. With HSAs, your contribution is tax deductible.

Used properly, HSAs have more tax advantages than other retirement savings options. You are not required to withdraw any of your contributions yearly even if you had medical expenses that would be deemed allowable.

You are allowed to roll over to the next year all contributions you did not withdraw. There is no limit on the amount you may roll over. In the long run, you are better off paying your medical expenses with non-HSA funds, if you can, so your HSA will increase in value.

When you reach 65 and apply for Medicare, you will no longer be able to make new contributions. However, you can pay your medical expenses from your HSA account without incurring taxes. You can even pay your Medicare premiums with these funds. Prior to age 65, you cannot pay insurance premiums with these funds.

After 65, you may use the funds for expenditures unrelated to health care without penalty. However, this is not advisable because the withdrawals would be taxable.

Widows and widowers who inherit HSAs can use the proceeds for their own HSA even if they did not qualify for one during their working years. As long as the funds are used for medical expenses, the expenditures are not taxable.

Many organizations offer HSAs. You are not locked into the HSA your employer selected. You should look for a provider that offers you growth potential alternatives with low costs. You generally can roll over your funds to a different provider. Leo Acheson of Morningstar evaluated the available options, taking investment options and cost factors into account.

Acheson found that Bank of America, Health Equity and HSA Authority were excellent choices for long-term investments. For example, HSA Authority uses Vanguard funds with low expense ratios and multiple options.

Contribution limits in 2017 are $3,400 per year per individual, and $6,750 per family. If you are older than 55, you can contribute $1,000 more.

The bottom line is that those eligible to use an HSA should evaluate their long-term potential, use the best alternatives and look at their long-term potential as an aid in retirement planning.

Elliot Raphaelson welcomes questions and comments at raphelliot@gmail.com.

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