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Three healthy habits for health savings accounts

These simple strategies can benefit almost everyone who has a health savings account.

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Although many organizations today offer high-deductible health plans (HDHPs) paired with health savings accounts (HSAs), many Americans are still unfamiliar with HDHPs. If your company offers this option and you are not taking advantage of it, you may be missing an opportunity, as HDHPs and HSAs can play a valuable role in your financial wellness.

In the past, you may have heard that HSAs were a convenient way to pay for out-of-pocket costs, such as doctor visits or prescriptions at your local pharmacy. But did you know that HSAs can be used in a variety of ways to help manage other current qualified medical expenses—as well as to pay for future medical expenses, such as your qualified medical expenses in retirement?

HSAs: The basics

HSAs are individual accounts typically offered by employers in conjunction with an HDHP to cover qualified medical expenses. If you put money in an HSA and use that money to pay for a doctor’s visit or another qualified medical expense any time in the future, you never pay federal taxes on the money. And although state taxation may vary, most states follow the federal tax law.

What’s more, unlike health flexible spending accounts (FSAs), HSAs are not subject to the “use-it-or-lose-it” rule. Funds remain in your account from year to year, and any unused funds may be used to pay for future qualified medical expenses.

The IRS maximum annual contribution limit for HSAs in 2014 is $3,300 for those individuals electing single coverage and $6,550 for those electing family coverage under an HDHP. Individuals age 55 and older in the calendar year may contribute an additional $1,000 (this applies to both single and family coverage).

You can use your HSA to pay for some or all of your qualified medical expenses each year and let the rest of the money in your HSA potentially grow for use in the future, including in retirement. Or, if you have the cash to pay your medical costs out of pocket, you can let your HSA grow tax free for future qualified medical expenses.

For how the Internal Revenue Service defines “qualified medical expenses,” read IRS Publication 502 and IRS Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans.

Now for the first time, an employee with an HSA is allowed to pay for qualified medical expenses of their same-sex spouse, thanks to the Supreme Court ruling last year that invalidated the law barring the federal government from recognizing same-sex marriages. However, there is one drawback with respect to HSAs—each spouse will no longer be able to contribute up to the statutory maximum allowed. They will now have to follow the spousal proration rules.

Three healthy HSA habits

We believe there are three simple and effective “healthy habits” that can help you get the most value from your HSAs, both now and in the future.

1. Cover anticipated out-of-pocket health care costs.

Each fall, during annual enrollment, you have the opportunity to make health care choices that serve the needs of you and your family for the coming year. You may be wary of enrolling in an HDHP plan because you are concerned about potential out-of-pocket costs. You may worry, “What happens if I get really sick or have a catastrophic accident? Where will I get the money to pay the higher deductible?”

These are valid considerations. To start with, you should factor in the deductible and any out-of-pocket costs. But what you may not realize is that you may be paying more than $2,000 every year in premiums for a “lower-deductible” plan (such as a traditional preferred provider organization [PPO] plan)—whether you need services under the plan or not. A “worst-case scenario” typically is going to occur only for a small number of people, and HDHPs generally provide generous coverage above the higher deductible, including an out-of-pocket maximum for protection. What’s more, most preventive care and screenings are now required by law for most employer-sponsored health plans.

Generally, those who choose traditional health plan options may be paying higher premiums, while those who elect an HDHP generally pay a lower premium for health coverage and can direct those premium savings to their HSA to help cover any “worst-case” expenses.

Consider contributing enough into your HSA so that you have enough cash on hand to cover anticipated or unanticipated out-of-pocket qualified medical expenses for the year. This approach can help you better prepare for an unexpected trip to the emergency room or an unforeseen health issue in the coming year.

Also, while you cannot be enrolled in an HDHP and a general purpose FSA, more employers are offering HDHPs with the option to enroll in both limited-purpose FSAs and HSAs, meaning you could set aside up to $2,500 in your limited-purpose1 FSA for this year’s qualified medical expenses and additional money in your HSA. However, the amount you set aside in your FSA will still face the same use-it-or-lose-it rule by the end of the year.

2. Take advantage of available employer contributions.

If your company supports your efforts to save, with an employer contribution to your HSA, you’re in good company. In 2012, nearly 93% of employers that offered HSAs made a contribution to employee HSAs, with an average annual contribution of $884.2

Combined with your own contributions, the savings of accumulated contributions can go a long way to meeting any anticipated qualified medical expenses. While employers may have different rules and timing for their contributions, a common approach is to put the full employer contribution in your account as soon as you enroll in the HDHP and open your HSA.

3. Save and invest for future qualified medical expenses.

Many financial professionals suggest that individuals can benefit from tax-advantaged vehicles such as workplace savings plans and HSAs. While individual tax situations will vary, the triple tax advantages offered by HSAs merit a closer look. Generally, an HDHP with an HSA enables you to set aside pretax dollars through payroll deductions. An HSA can also be funded with after-tax dollars, which the individual will take as a tax deduction on his or her personal taxes. These contributions can accumulate tax free and can be withdrawn tax free to pay for current and future qualified medical expenses, including those in retirement.3 An HSA balance can remain in your account from year to year, and you can take it with you when you leave your job.

For example, let’s say you have family coverage in an HSA-eligible health plan. You save $3,000 in your HSA for future use and you plan to spend $2,000 on various out-of-pocket health care expenses this year (e.g., co-pays, prescription drugs) without dipping into your HSA (option 1, below). If you want to consider a strategy that can provide additional tax advantages,4 increase your pretax HSA contributions to $5,000. Then spend $2,000 tax-free dollars directly from your HSA on your out-of-pocket expenses (option 2, below).

Because many employers are dropping or cutting back retiree medical coverage, planning for medical expenses both now and in the future, including in retirement, can be an important part of your overall savings plan.

For many Americans, health care is likely to be among their largest expenses in retirement. A 65-year-old couple retiring in 2013 is estimated to need $220,000 to cover medical expenses throughout their retirement.5 Fortunately, employees who have access to an HDHP through their employer may have the option of saving and investing in an HSA. Just as investing for retirement is a priority for most Americans, investing in a tax-advantaged HSA to help pay for current or future qualified medical expenses is becoming just as important.

Consider contributing the maximum that you can afford to your HSA, up to your maximum annual contribution limit. For the portion of the HSA that you are saving for the future, you might want to consider investing that portion of your HSA balance in an asset mix in line with your longer term savings goals.

Summary

HSAs offer a number of benefits both for short-term spending and for saving for longer-term qualified medical expenses, including those in retirement. The three healthy habits outlined here can help you better understand how to take advantage of this growing health care savings opportunity.

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1. Limited-purpose FSAs may be used to pay for uncovered dental and vision care expenses, as well as preventive care.
2. Fidelity recordkept data as of December 31, 2012, based on 121,000 Fidelity HSA account holders who contributed at least $1 during 2012.
3. Tax advantages are with respect to federal taxation only. Most states follow federal tax law. As of April 21, 2014, only the following four states do not follow federal law in regard to deductibility and/or tax treatment of distributed gains: California, New Jersey, Alabama, and Pennsylvania.
4. Contributions, investment earnings, and distributions are tax free for federal tax purposes if used to pay for qualified medical expenses, and may or may not be subject to state taxation. For additional information, see IRS Publication 969. The administration of an HSA is an individual responsibility; see a tax professional for more information.
5. Fidelity Benefits Consulting, 2013. Based on a hypothetical couple retiring at age 65 or older, with average (82 male, 85 female) life expectancies. Estimates are calculated for “average” retirees but may be more or less depending on actual health status, area of residence, and longevity. Assumes individuals do not have employer-provided retiree health care coverage but do qualify for Medicare. The calculation takes into account cost-sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B (inpatient and outpatient medical insurance). It also considers Medicare Part D (prescription drug coverage) premiums and out-of-pocket costs, as well as certain services excluded by Medicare. The estimate does not include other health-related expenses, such as over-the-counter medications, most dental services, and long-term care.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.
Fidelity does not provide legal or tax advice, and the information provided above is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific legal or tax situation.
The information provided is general in nature and is not intended, nor should it be construed as, legal or tax advice. Since the administration of an HSA is a taxpayer responsibility, you are strongly encouraged to consult a tax adviser before opening an HSA. You are also encouraged to review information available from the Internal Revenue Service (IRS) for taxpayers, which can be found on the IRS Web site at www.irs.gov. You can find IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and IRS Publication 502, Medical and Dental Expenses (including Health Coverage Tax Credit), online or you can call the IRS to request a copy of each at 800-829-3676.
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