Health Savings Accounts, or HSAs, are available to people that have a high-deductible health insurance plan. The HSA is used for medical expenses such as your deductible, co-payments, medications, prescription glasses and dental care. The cash deposited into an HSA is pre-tax money. And money withdrawn from the HSA is also tax-free if used for the qualified medical expenses just mentioned.
Think of HSA contributions as being similar to 401(k) contributions, but in an account that’s accessible for medical expenses. You can deposit up to $3,250 for a single person or $6,450 per family for 2013. If you are 55 or older, then you can deposit up to $4,250 for a single person or $7,450 for a family.
Many people may already be aware of this great tax-free benefit by contributing to an HSA. Still not convinced to contribute to an HSA? Then please read on.
The money put into an HSA doesn’t have to be used each year. Any unused money can be used the following year or in 20 years! There is no time limit to use the money and HSAs are not “use-it-or-lose-it” accounts like their inferior cousin called flexible spending accounts (FSAs). The ability to accumulate a balance in your HSA is one of the key factors that make it such a great deal.
The other key factor is that the money saved up in an HSA can be invested in mutual funds. This allows your money to grow tax-deferred until you need it for future medical expenses. And what might be some of these future medical expenses? Glad you asked because now we get into the cool stuff.
Younger people far from retirement probably don’t know this, but Medicare isn’t free. Medicare has a monthly premium of $105 per month, deductibles, co-pays and prescription drug costs. We all have plenty of future medical expenses to look forward to.
This is where the power of an HSA really starts to pay off. Accumulating an HSA balance is just like saving for retirement, but this money is specifically set aside for your future Medicare costs in retirement. And don’t forget that it’s all tax-free money!
So let’s use an example to show how this might work. Joe is a 35-year-old guy that diligently contributes $3,250 per year to his HSA for 30-years until he’s 65 years old. He used about a third of each year’s contribution for medical expenses, but allowed the other two-thirds to accumulate in his HSA. Joe chose low-cost mutual funds to invest his growing HSA balance and was able to earn an average annual return of 5 percent.
What is Joe’s balance in his HSA when he retires at age 65? If you guessed $144,000 then you would be correct. Imagine having that much money saved up to pay for future Medicare costs! All of Joe’s friends will be paying their Medicare with after-tax money while Joe pays his with tax-free money.
Joe is one smart dude. His HSA was good for his health and even better for his wallet. Next time you select health insurance, be sure to take a look at a high deductible plan. If it’s right for you, then be sure to open an HSA to take full advantage of this great benefit.
Steve Doster is a Certified Financial Planner™ professional providing commission-free financial advice for do-it-yourself investors. You can reach Steve at Doster Financial Planning by phone 619-688-1192 or email steve@dosterfinancialplanning.com. You can also follow Steve on Facebook, Linked In, Twitter, or blog to get more personal finance advice and tips.
