One of my favorite stories of old Hollywood is the one about W.C. Fields sitting on his front porch reading the Bible. A friend sees him and says, “Hey, Bill, are you getting religion?”
Fields looks up from the book and replies, “Looking for loopholes, looking for loopholes!”
The ultimate loophole available to almost everyone under the age of 65 in our tax code is the Health Savings Account (HSA). It is the only account you can contribute to and deduct the contribution and then withdraw the money tax free.
Think about that, a tax deduction going in and no taxes going out.
There are rules that must be followed. Anything to do with the government has rules, but the HSA rules are not complicated. Here is a simple synopsis:
- You must have a high deductible health insurance plan. This is often called a “HSA compatible plan.” Most group plans from employers offer this option. A high deductible can be anything from $3,500 to $10,000. If you have a compatible plan, then you may open an HSA.
- The maximum that can be contributed each year depends on the people covered under the health insurance plan. A single employee coverage means the maximum in 2024 that can be contributed is $4,150. If you have a spouse or family member covered on the insurance the maximum contribution in 2024 is $8,300. In addition to these limits if you are over the age of 55 you can contribute an extra $1,000. So, a couple over age 55 may contribute $10,300 for this year. The limits are raised each year for inflation.
- Money in the HSA may be used to pay or reimburse for medical, dental, optical, and hearing aids. When withdrawn for these expenses there are no taxes due. It can be used to pay for medical insurance deductibles, copays, out-of-pocket expenses, dentist, ophthalmology, audiologist, eyeglasses, and contacts.
- The account is owned by you and any funds not used in the current year may accumulate and be invested. Generally, most HSA banks will allow any amount over $5,000 to be invested in mutual funds or exchange traded funds (ETFs). It is a great vehicle to accumulate money for retirement. Even with Medicare there are many expenses not covered that HSA monies may be used for. Dental expenses and hearing aids are two very costly items for retirees.
- The annual contribution limit is the total contribution from both your and your employer combined. Many employers will make some contribution to the HSA on the employee’s behalf. Often, the employer will contribute the difference between what a non-HSA compatible plan will cost versus a lower deductible plan.
- No contributions may be made after age 65. Because of this rule I encourage clients to make the maximum contribution each year and try to accumulate as large of an account as possible for retirement. Reaching the age 65 with $100,000 or more in an HSA is a great retirement benefit. I can assure you that most retirees will spend more than that on medical, dental, and vision costs.
When working with a client we prioritize what accounts a person should have, an HSA is at the top. It is the only account that is tax deductible and can be withdrawn tax free. Second to an HSA would be a Roth IRA or Roth 401(k) which is not tax deductible but tax free going out. Third would be a traditional IRA or 401(k) pre-tax account. These are tax deductible for the contributions but taxed as ordinary income coming out. In some situations a regular taxable account could be more beneficial than an IRA or 401(k) pre-tax account because of the capital gains taxation.
The HSA is the ultimate account to have and should be the first a person should try to set up and then fund to the annual maximum. Knowing when and what accounts to use for an individual is one of the most important services a Certified Financial Planner™ offers. If you want to see how this account and others can help you contact a local adviser with the CFP® marks.
Wes Shannon CFP®is a Certified Financial Planning Professional for Brazos Wealth Advisors.
