While the growth in healthcare expenses has slowed in recent years (3.6 percent in 2013), it’s still growing substantially higher than the overall inflation rate (1.5 percent for 2013). For this reason, it’s a good idea to utilize saving, spending and investment options available with today’s popular health savings accounts.
Health Care Flexible Spending Arrangement
A Flexible Spending Arrangement (FSA) is an employer-sponsored health savings account that allows you to defer pretax income to pay for qualified medical expenses each year. Employers also may offer either (1) up to $500 in unused funds carried over to the next plan year, or (2) an extra 2½ months into the next year to incur and pay for expenses.
Health Savings Account
A Health Savings Account (HSA) may be offered in concert with a high deductible healthcare plan (HDHP). The HDHP+HSA strategy offers multiple tax advantages: an upfront income tax deduction, tax-deferred growth of contributions and tax-free withdrawals for qualified healthcare expenses. If an employer makes contributions to your HSA, they are free of FICA taxes.
Emergency Savings Strategy
If you contribute to an HSA but pay for out-of-pocket medical expenses with current income, save your receipts because you can withdraw funds to reimburse yourself at a later date – even years later. Used in this manner, the HSA makes for a nice emergency savings account.
HSA Retirement Strategy
If you pay for healthcare expenses out-of-pocket, your HSA contributions will be able to compound unfettered for years before you retire. After age 65, you’ll pay no taxes on medical expenses and only income taxes (no penalty) on nonqualified withdrawals, which makes the HSA an additional tax-free savings vehicle for retirement.
In fact, for some people saving with an HSA can be even more advantageous than through a traditional IRA. First of all, the $6,650 annual contribution for a family account (in 2015) is higher than the IRA contribution limit. Second, there is no income limit for deducting contributions – even if you earn $1 million a year.
IRA to HSA Rollover Strategy
You can avoid income taxes on traditional IRA assets via a direct transfer (up to your annual HSA contribution limit) to an HSA. With this strategy, you avoid having to pay taxes or penalties on the IRA distribution and, as long as you use the money for qualified medical expenses, avoid ever having to pay taxes on that money altogether.
Note, however, that this strategy does have a few drawbacks: (1) You can use this strategy only one time; (2) the IRA rollover contribution does not qualify for a tax deduction; and (3) the transfer is subject to a 12-month testing period during which you must remain HSA-eligible.
HSA Strategy for Older Employees
Seniors still in the workforce can combine health savings account strategies to help give their retirement savings an extra boost. If you delay signing up for Medicare, you may continue making tax-free contributions to an HSA. Once you turn age 70½, you might have to begin taking required minimum distributions from a traditional IRA, but you can use that money to make HSA contributions and claim the income tax deduction.
If available, save money tax free through a limited-use FSA. Then use those FSA funds to reimburse out-of-pocket vision and dental expenses so you don’t have to tap the HSA for them – which will enable your HSA more opportunity to grow tax deferred.
HSA Investment Opportunity
An HSA also offers investment options once you reach a minimum account balance, so your money has the opportunity to grow over time. Over the past three years, HSA accounts have produced an average annualized return of 12.5 percent.