HSA accounts are awesome and if you are covered under an HDHP you should be contributing to yours.
Post done; I’m going to go have a home brew while cleaning the bike. But, if you insist I will elaborate. HSA stands for Health Savings Account. These are tax advantaged accounts that you are allowed to contribute to while covered by a HDHP (High-Deductible Health Plan). The money in the HSA can be used to pay for qualified medical expenses tax free. A participant in a high-deductible health plan may face higher out of pocket expenses than a participant in a higher monthly cost but lower deductible plan. To compensate for this the HSA was legislated into being to allow HDHP participants to save for those deductibles with a tax incentive thrown in to sweeten the pot.
All the way before tax
HSAs are contributed to pretax much like a traditional IRA or 401k. In addition, as long as contributions are made through payroll deductions then the Social Security and Medicare tax of 7.65% isn’t owed on the portion of the funds contributed. This is head and shoulders above the 401k and IRA in which yes, you get to defer the income tax but, you’re still on the hook for the FICA tax.
With a Roth IRA or Roth 401k the contributions are taxed and the distributions are not. With a HSA as long as the distribution is spent on qualified medical expenses the distribution isn’t taxed.
An HSA is contributed to before tax and distributions are made without being taxed. This is why I say HSAs are awesome. This is one of the very few times in life that you can have your cake and eat it too.
How do I get at the money?
You swipe the card that the account provider issues you at the health service provider. Seriously, it is that easy. The money was deposited in the account pretax and was withdrawn without owing tax. The plan just worked as intended and you got medical care without paying taxes on the money used to pay for it. But, what if you don’t have many medical expenses? Well, you end up with money left over in the account. Which stays in the account year after year compounding on itself.
At age 65 you can start taking distributions from the HSA without penalty for any expense. Income taxes will be owed on the amount withdrawn but, the funds were deposited pre-tax so the end of the tax deferred rainbow has been reached. The tax man gets his due and the funds are available for your use. I call this a win.
There isn’t currently a time limit between the time the medical expense it incurred and when the funds are withdrawn to reimburse for the expense. One could pay for medical expenses out of pocket save the receipt and be able to withdraw that amount from the HSA at a future date without owing tax on the distribution. This part seems like an oversight to me. I expect a time limit to be placed in the rules at some point. But if one follows this line of reasoning you end up with the conclusion that the Mad Fientist reached in his HSA article.
For 2016 the contribution limit is $3,350 for individuals and $6,750 for a family. This is based on whether you have a family or individual HDHP plan. There is also a $1,000 catch up contribution available if one is between the ages of 55 and 65. If you are covered under an HDHP for part of the year then the amount you are allowed to contribute is 1/12 times the number of months you are eligible times the federal limit for that year. So if in 2016 you were covered by an individual HDHP from January through April the maximum that could be contributed to the HSA is 4/12 * $3,350 or about $1,116.67. If it’s your first year of coverage under a HDHP the full amount can be contributed but there is a testing period to make sure you stay covered through the end of the following year.
Where to open an HSA
More and more financial institutions are getting in on providing HSA services. Banks and Credit Unions are generally the deposit taking institutions that will provide an HSA. Selection criteria for an institution is the normal fees, investment options, customer service trifecta.
If you are making contributions through payroll deductions your employer will either have an account setup or tell you where to open the account at so they can deposit the deductions for you. Many employers will cover the monthly fees for having the account open. If you are shopping around and opening an HSA yourself on your own behalf watch out for monthly account fees.
Most HSA accounts will require that you keep a certain amount of the balance in cash. But the rest can be invested. With my current account I have to keep a cash balance of $500 in cash in the account and everything else is automatically swept into an S&P 500 Index fund. Most accounts don’t offer a full brokerage window like you can find in some IRA accounts. The investment menu for most HSA accounts is more similar to the number of options offered in most 401k accounts.
In a very similar manner to 401k and IRA accounts HSAs can be rolled over. If you find that your current provider is charging too high of a monthly fee, isn’t paying enough interest, has a poor selection of investment options, or just generally manages to earn your ire you can roll the HSA to a new provider. Most providers are ready and willing to assist in opening an account and funding it with a roll over from another provider. The handful of times I have done this it takes some phone calls and some paper work signing. It is less of a hassle than applying for a mortgage but more than just opening a checking account.
I make contributions to the HSA spread across the entire year instead of front loading. I do this because I make contributions through payroll deductions and that is just the way payroll is setup to process it. Spreading it out also makes sure that I haven’t over contributed in case I suddenly find myself no longer covered by the company provided HDHP plan.