How To Take Full Advantage of an HSA Account (it’s not what you think)

​Most people who have Health Savings Accounts (HSA’s) use the account to pay medical expenses that occur each year. For many folks, this is potentially a huge mistake. There’s a better strategy!!

HSA’s can be the most powerful retirement strategy in your financial plan, if handled strategically. That’s because HSA’s have a triple tax benefit with the IRS & most states: tax deductible contributions, tax-free growth, and tax-free distributions (if used for qualified medical expenses). HSA’s are like a Traditional IRA and Roth IRA combined, taking the best of both worlds! And unlike an FSA, the HSA’s ability to roll your funds from one year to the next allows the compounding growth on the account.

But in order to take advantage of all three benefits, you cannot deplete the account as medical expenses occur. For example, if you contribute $5,000 to your HSA and then turn right around and distribute the $5,000 to pay for eligible medical expenses, then you’re not allowing the account to grow tax-free and are not maximizing the tax-free distribution (since you cutoff the longevity needed for the account to grow).
 
The Strategy
Assuming you have sufficient surplus funds, the strategic HSA handling goes as follows:

1. Contribute the max each year to your HSA
2. Invest your HSA funds into your chosen mutual funds, stocks, etc…just as you would any other retirement money
3. As medical expenses occur, use other savings to pay the expenses instead of using your HSA (that way you keep the account funded and accumulating, in order to give your chosen HSA investment funds time to grow)
4. Keep the account accumulation intact until you really need the HSA to pay expenses

 
Again, one of the biggest benefits of an HSA is the fact the savings feature grows and distributes tax free. But if you contribute to the HSA and then withdraw the money the next month, the only benefit you're getting is the tax deduction from the contribution. To take full advantage of the tax-free growth and distribution feature, you want to leave the money in the account for a long time.
 
So if you have sufficient funds, use other savings to pay for health expenses in the short-term, and let your health savings account grow. Then use your HSA later in life. That way you're also distributing tax-free money at a time when the majority of your income might be taxable!
 
Added Benefits

1. Once you hit age 65, you can even use HSA funds to pay non-medical expenses. While these distributions won’t face IRS & state penalties, you would be taxed as ordinary income on these amounts, which make the distributions just like a Traditional IRA at that point.
2. HSA’s don’t have required minimum distributions (RMD’s), like 401k’s and Traditional IRA’s. So you can take advantage of longer growth on the full value of the account.

 
Diligence
This does require you to track medical expenses over time so you can “cite” eligible expenses for the justification of withdrawals (when that time comes). You don’t necessarily have to have the medical expenses occur in the year of distribution. But if you’re using past years’ expenses as justification for any withdrawals, you’ll need that tracking. We suggest a simple spreadsheet where you track medical expenses as they occur, with your sheet containing the date of expense, service provider, and amount paid. You’ll also want to scan in receipts for those transactions so you have a great paper trail! Keep a lifetime log!
 
Also, make sure you meet the following requirements for medical expenses to be eligible:

1. Expenses must be incurred after HSA establishment
2. Expenses aren’t allowed to have been previously paid, or reimbursed from another source
3. Expenses can’t have been taken as an itemized deduction in any year
4. You must meet eligibility requirements to have an HSA. Click here for IRS site info and most recent updates on this.

 
What If The Account Owner Passes Away?
One hesitation some folks have with HSA’s is the fear of contributing too much to an HSA and not having sufficient qualified medical expenses for distributions. HSA’s have an answer!

• If the account holder’s spouse is the designated beneficiary of the HSA, it will be treated as the spouse’s HSA after the account holder’s death. So things just continue on with the surviving spouse.
• If the account holder’s designated beneficiary is someone other than the spouse, the account stops being an HSA and the value of the HSA becomes taxable to the beneficiary in the year of the account holder’s passing. However, the taxable amount to a beneficiary is reduced by any qualified medical expenses for the decedent. So it’s important for the account owner to inform any beneficiaries of the medical expense tracking document & receipts, and to make that available for the beneficiary in order to lower the tax impact.

 
Hope this helps! It’s a little-used, fantastic strategy with HSA’s!
 
Contact us if you have questions as it pertains to your specific situation…we’re happy to help!