Although many organizations today offer a high-deductible health plan (HDHP) paired with a health savings account (HSA), many Americans are still unfamiliar with HDHPs and HSAs. 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 qualified medical expenses, such as those in retirement?
HSAs: the basics
HSAs are individual accounts 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 now or 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 some 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 2015 is $3,350 for those individuals electing single coverage and $6,650 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 entire HSA grow tax free for future qualified medical expenses.
For how the Internal Revenue Service defines “qualified medical expenses,” read IRS Publication 502: Medical and Dental Expenses and IRS Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans.
Three healthy HSA habits
We believe there are three simple and effective “healthy habits” that can help you get the most value from your HSA, 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 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 a traditional health plan option 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. If you don’t have much information or much time, we suggest a conservative approach, estimating cash needs equal to the in-network deductible for your plan.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 may still face some use-it-or-lose-it rules.
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 2014, 29% of all HSA dollars contributed to an HSA account came from an employer. The average employer contribution was $938.2
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 annual 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.
Most 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 . 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 . You could use this tax savings ($500 in this example) to save more for retirement.
A Fidelity-sponsored survey found that HSAs can play an important role in saving for future health care expenses, including those in retirement. Here’s one surprising finding: Some people who spent the majority of their HSA dollars on qualified medical expenses in a given year were able to save nearly $3,000 in their HSA over a five-year period.5 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 2014 is estimated to need $220,000 to cover medical expenses throughout their retirement.6 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. You might want to consider investing the portion of the HSA that you are saving for the future in an asset mix in line with your longer-term savings goals.
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.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917