High Earners and Health Savings Accounts

High earners are often looking for ways to strategically save on taxes while boosting their financial outlook. Health savings accounts (HSAs) are a great option for accomplishing this because they provide an uncommon three-point tax benefit: contributions reduce your taxable income, investments within the account grow tax-free, and, as long as you spend the funds on qualified medical expenses, the withdrawals are tax-free too. Additionally, HSAs have fewer restrictions and more benefits than flexible savings accounts (FSAs).

• How do Health Savings Accounts work?

An HSA is an account that is exempt from federal taxes and intended to help individuals and families pay for certain healthcare expenses. Those who are eligible can contribute to their HSA on an annual basis and receive a tax deduction without needing to submit an itemized return. Qualified medical expenses that count for tax-free withdrawals include co-pays, prescription drugs, vision or dental care, chiropractic services, fertility treatments, and other out-of-pocket costs. Ineligible expenses, whether medical or non-medical, will incur a 20% tax penalty in addition to being taxed as ordinary income. However, if you’re 65 or older, you can take withdrawals from the account for any reason without penalty, but you’ll still need to pay income taxes if the funds aren’t used for qualified expenses.

HSAs normally begin as a cash-only account that earns interest and once the balance reaches a certain amount you can start investing the funds. The minimum threshold required before you can start investing is set by the custodian where your account is held. Annual contribution limits for 2021 are $3,600 for individuals and $7,200 for families. Those who are 55 and older can make catch-up contributions of an additional $1,000 per year. These contribution limits assume you sign up at the beginning of the year, and they’re prorated by month if you join the plan after January 1.

• How do you qualify for an HSA?

Your health insurance coverage must be under a high deductible health plan (HDHP); this usually means that the plan has a deductible of at least $1,400 for a single person and $2,800 for a family. You can not open an HSA while enrolled in Medicare, but, if you are enrolled, you can continue to spend existing HSA funds, you just can’t contribute any longer. You don’t need an employer to provide your HSA, though many do; if you meet the eligibility criteria, you can open an HSA on your own.

• How is an HSA different from an FSA?

Health Savings Accounts are different from FSAs in a few ways. FSAs are only available as part of a benefits package from an employer. HSAs are only available to those who participate in an HDHP. FSAs are “use it or lose it” in that all funds must be spent each year or they’re forfeited, unless the plan has a grace period or rollover feature that is capped at $500. HSA balances never expire as funds will roll over year after year. FSAs are normally lost if you change jobs unless you’re eligible to keep yours through COBRA, but HSAs follow= you even if you change jobs and you can keep contributing even if you’re unemployed, as long as you still have an HDHP. Funds in an FSA can’t be invested either, they’re strictly cash-only accounts. Whereas HSAs can be invested in a variety of different investment options such as mutual funds, stocks, and bonds.

• Who should consider having an HSA?

High earners who would like to decrease their taxable income while simultaneously saving and investing for future healthcare expenses for themselves and their families are most likely to benefit from having an HSA. HDHP commonly have lower monthly premiums along with the higher deductible, so if you’re generally healthy and have income you’d like to offset, an HSA could be a beneficial part of your financial and tax strategy. The Federal tax benefits of HSAs are frequently highlighted, but it’s important to note that most states also provide tax advantages as well. Please note that California and New Jersey have unique tax rules surrounding HSAs, so residents of those states should speak with their tax advisor before proceeding.

As with any financial and investment decision, it’s always good to speak with a professional before deciding one way or another. If you’re not sure if an HSA is right for you and your family, reach out to a trusted professional such as a CERTIFIED FINANCIAL PLANNER™ or CPA for guidance. Since tax laws change regularly, be sure to check for any updates to contribution limits or other rules on at least an annual basis.