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Healthy Gains

James McGlynn

IT’S BEEN CALLED the stealth IRA. We’re talking here about health savings accounts, which offer a triple tax play. First, contributions are tax-deductible. Second, the accounts grow tax-deferred. Third, if the money is used to pay permitted medical expenses, there’s no tax on the sum withdrawn.

That might sound similar to an employer-sponsored flexible spending account for health care costs, but those are more restrictive. If much or all of the money isn’t spent by the end of the year, it’s forfeited. Think of health savings accounts (HSAs) as an improved version. Money in an HSA can be carried over indefinitely and the plan doesn’t cease with your job. Instead, the account stays with the employee—and, indeed, you don’t need to work for a large employer to set up an HSA.

To qualify for a health savings account, you must have insurance that’s classified as a high deductible health plan (HDHP). That’s defined as individual coverage with a deductible of $1,400 or above in 2021 or family coverage with a $2,800-plus deductible. The original intent of the HSA was to promote higher deductible plans, which should translate into both lower medical premiums and more thought before rushing off to see a doctor.

Oftentimes, employers will contribute to an HSA to lessen the risk that the accountholder can’t afford to pay the deductible. Even if your insurance plan has a $1,400-plus deductible, it’s a good idea to verify with the plan that it qualifies as an HDHP. My retiree medical plan originally didn’t qualify, but a few years ago the plan sent out a notice saying it now did, even though the deductible hadn’t changed.

The HSA contribution limits increased slightly in 2021. They’re $3,600 for an individual and $7,200 for a family, plus there’s a $1,000 catch-up contribution if you’re age 55 or above. You have until the mid-April tax filing deadline to make contributions for the prior year. This January, I contributed $4,600 to my HSA for 2021—the sum for an individual, plus my catch-up contribution—to get the account fully funded and invested early in the year.

My experience is with flex-spend accounts and employer-sponsored HSAs, both of which were easy to sign up for, thanks to my old employer’s benefits department. The good news is, even if your employer doesn’t offer HSAs, it’s possible as an individual to open an account at a brokerage firm or a bank. Many people who qualify for an HSA don’t have accounts, because their employer doesn’t offer them.

Where should you turn? Fidelity Investments recently eliminated fees for its HSA and it’s seen good investment performance, according to the researchers at Morningstar. Another highly ranked HSA is from fee-free Lively, which is affiliated with TD Ameritrade. My current HSA charges a $45 annual fee. I’m in the process of switching to Lively using a trustee-to-trustee rollover.

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Health savings accounts are especially attractive for high tax-bracket workers since the deduction is worth more than it is for those with lower incomes. To be sure, if you aren’t paying medical expenses, HSA contributions aren’t immediately accessible tax-free, as they are with Roth contributions. Still, the list of qualifying medical expenses is quite exhaustive. You can use an HSA to cover your deductible, copays, prescription drugs, and vision and dental care. The account can also be used to pay Medicare Part B, C and D premiums. In addition, it can be used for long-term-care insurance premiums—within limits. An HSA, however, can’t be used for Medigap or health insurance premiums.

While HSAs are intended to cover current medical costs, I’d also view the account as a way to notch tax-free growth, which you might then use to pay for medical expenses in retirement. But to get the most out of the account, you need to invest for long-term growth, rather than stashing the money in low-yield or no-yield safe investments. To leave the account to grow, consider paying cash for current medical bills—but be sure to save your medical receipts. You can use those receipts later to withdraw the amount involved from your account, while getting tax-free growth in the meantime.

Health savings accounts get a little trickier once you’re in or near retirement. If you aren’t currently on Medicare, you can contribute to an HSA, assuming you qualify.  But once you’re on Medicare, funding an HSA can trigger taxes and penalties. The rules are tricky, as I explained in an earlier article.

Another important point: If the beneficiary of an inherited HSA isn’t your spouse, then the HSA will be fully taxable. There isn’t even a deferral period, as there is with an inherited IRA. That means a charity would be an excellent HSA beneficiary if you’re a single adult.

At age 61, my current plan is to contribute to my HSA until I turn 65. I keep some of the account in cash, but 80% or so is invested in the stock market. Once I turn 65, I may use the account to pay my Medicare and long-term-care insurance premiums, while leaving other accounts—notably my Roth IRA—to keep growing. The Roth account will be tax-free for my heirs and can continue to grow for 10 years after death. By contrast, the HSA would be immediately taxable to my children, so I plan to spend down that account first. An HSA has many virtues. Being a good inheritance isn’t one of them.

James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. Check out his earlier articles.

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rgscl
rgscl
2 months ago

I am a fan of HSA as well and thanks for this great write up. My question to you is, is there a time limit to when one can withdraw HSA money for a past medical expense? As in, if I had spent $1,000 4 years ago, can I draw the HSA money now (or when I need it) using the receipts from 4 years ago?

Thanks again

Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  rgscl

Yes, if you have the necessary receipts, you should be able to make a tax-free withdrawal.

Enrique Romo
Enrique Romo
5 months ago

Thanks for this article Mr. McGlynn—question for you—our family fully funds its HSA but due to my son’s chronic health condition we spend it to zero every year. In this situation, are you suggesting leaving the HSA untouched and spending hard dollars to cover expenses?

James McGlynn CFA RICP®
James McGlynn CFA RICP®
5 months ago
Reply to  Enrique Romo

Enrique -yes with 3 caveats. 1. You have enough cash elsewhere to pay the bills. 2. You save the receipts. 3. You realize you are taking a risk that the HSA can decline in value in a down market. Currently you are not taking market risk. Because the HSA portfolio can grow tax-free investng the HSA can provide more funds to pay the bills. BUT remember that you are taking market risk!

sc9182
sc9182
6 months ago

If Employer sponsored HSA plan used via Payroll contributions (usually via employer Cafeteria plan) – in such scenario, even the FICA (Social Security & Medicare) taxes are NOT applied on the contributions .. (along with AGI reduction helping towards stimulus, Roth contributions, FAFSA, or Obamacare, among other things). That makes HSA quadruple tax advantaged!!

Also, after Agee 65 — you can convert/transfer HSA account/monies to regular IRA — preventing any “immediate taxation” upon non-spousal inherited account. (Then again – when that need to be done – can it be done after death — doubt it!! So, there might be some planning window/opportunity you have to seek for such IRA conversion; Alternatively- if HSA end up being too large after 65, besides reimbursing for saved receipts, change a portion of HSA to IRA to open up 10-year window for non-spousal beneficiaries ..)

James McGlynn CFA RICP®
James McGlynn CFA RICP®
6 months ago
Reply to  sc9182

I don’t think the HSA can be converted to an IRA. Money can be withdrawn after age 65 without the 10% penalty but not stashed in an IRA.

Roboticus Aquarius
Roboticus Aquarius
6 months ago

Just a note that the higher your marginal tax rate, the greater the effective discount you get on current medical expenses. Our family has had unfortunately frequent need for medical services, but our HSA has provided us with a significant discount for years now.

Not that I don’t look forward to socking away $9K or more to grow tax free, I’m just not sure it’ll ever make fiscal sense for us…

Charlie Warner Jr
Charlie Warner Jr
6 months ago

Good article, thanks. My wife and I are both on Medicare now and no longer eligible to contribute to our existing HSA account that has a balance of about $20,000. We are both blessed to have a corporate HRA accounts that our retired-employers contribute to annually. These HRAs cover most of our current medical expenses and our Medicare premiums. If we exceed our HRA totals, I struggle with weather to use my HSA account or just use after tax dollars? As noted these HSA funds are growing tax free. 

wtfwjtd
wtfwjtd
6 months ago

Great article James. I’ve also grown fond of HSA accounts, as there are many things to love about them. In addition to all the reasons you mention, married couples who are both over 55 and covered under one family plan can contribute up to $9200 per year, provided they each have their own HSA account. And NO pesky RMD’s to bother with either! Oh, and you don’t need so-called “earned” income in order to contribute, either; most any old funds you happen to have lying around will do.
HSA’s are a powerful tool that if properly leveraged can boost one’s retirement assets substantially. It’s too bad that more people aren’t using them.

R Quinn
R Quinn
6 months ago
Reply to  wtfwjtd

No pesky RMDs, but tax free use of the funds is limited to qualified medical expenses, not exactly retirement assets, but at least you can offset all premium costs which can be especially handy if subject to IRMAA premiums. The problem with how employers are using them is that lower income workers can’t afford to fund or deal with high deductibles.

D.J.
D.J.
6 months ago

Thanks, James. Californians should note, however, that the state still taxes HSA contributions and gains. CA residents might want to consult their tax advisors about how to approach HSA investments. They might also want to contact their CA state senator and assembly member, too.

Mark Royer
Mark Royer
5 months ago
Reply to  D.J.

Let’s hope and pray that the current regime in Washington does not copy this bad idea from the Golden State.

Guest
Guest
6 months ago

Mr. McGlynn –

Thanks for your educational column. You wrote that Fidelity recently eliminated fees for its HSA. I’ve had my HSA with Fidelity for a few years and have never been charged any fees at all. I’m very happy with mine as I can invest the $$ in virtually any investment I want and also no fees.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
6 months ago
Reply to  Guest

This looks like another fild where both Fidelity and Ameritrade? Schwab see the benefit of fee eliminations. Perhaps Fidelity charged fees on individual accounts before and not now. Either way glad you are happy with them.

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