Don't Overlook HSAs During Open Enrollment Topics Reference Advisors Markets Simulator Academy Search News, Symbols, Terms « Advisor Insights Don't Overlook HSAs During Open Enrollment Ed Snyder Ed Snyder, CFP®, ChFC November 15, 2017 SHARE Open enrollment is coming. You know, that time of year where you make choices about your benefits at work? One area that I've noticed that people may want to take a little more time in comparing their options is in the health insurance plan that they choose. With many employers today you can choose from two options - a health reimbursement account (HRA) or a health savings account (HSA). You may have heard about the HSA, but maybe you're not sure how it works or how to use it. HSAs are relatively complex and can be confusing. Is it affiliated with health insurance? Does it have anything to do with retirement? Is it a bank account, an investment account? It can be all of these things. (For more, see: Rules for Having a Health Savings Account.) Tax Benefits of HSAs HSAs are available to those that have high-deductible insurance plans. The money in the HSA can be used to meet deductible and other out-of-pocket health care costs. The money goes in pre-tax, like the money you put in your 401(k). Investment growth and interest are tax deferred and withdrawals spent on qualified medical expenses are tax free. This triple tax benefit increases your buying power compared to using after-tax money. For example, let's say you had $1,000 in medical expenses for the year. If you pay those expenses from money that you had in your HSA, you would be paying them with money that had not been taxed. But if you did not have an HSA and paid the expenses from after-tax money (assuming a 25% federal income tax bracket and 5% state income tax), your $1,000 in medical expenses would cost you $1,428.57. Why? Here's the math. $1,428.57 - $357.14 (25% federal income tax) - $71.43 (5% state and county income tax) = $1,000 after tax. You can see the year-to-year savings potential of an HSA from this example. Long-Term Retirement Savings You can also use an HSA for long-term retirement savings by paying your current medical expenses out of pocket, while making contributions to your HSA. You can let the HSA balance grow, much like you would an IRA or 401(k). The maximum amount you can contribute to an HSA for 2018 is $3,450 for individuals or $6,900 for families. And you may get some help from your employer with those contributions. Last year, 26% of employers helped offset the costs of HSA contributions by making contributions to employee accounts. Those contributions averaged $868, according to Devenir, a consulting firm that works with HSA providers and employers. Let's assume that a worker is 40 years old, works until they are 65 and contributes $6,900 each year to his or her HSA. We'll assume a 4% average rate of return on the money invested in the HSA. At age 65, the HSA balance would be over $290,000. As long as that money is used for qualified medical expenses it will not be taxed. A recent estimate by Fidelity Investments indicates a couple retiring this year will need $275,000 to cover health care costs in retirement. I think you will likely have plenty of health care costs that you can use it for. (For related reading, see: How to Use Your HSA for Retirement.) Other HSA Features But what if you leave your current employer? What happens to your HSA? Money in your HSA rolls over at the end of the calendar year and HSAs are portable - that means you take it with you when you leave your employer. They are individually owned and not tied to employers. When you retire or leave your employer for any other reason, your HSA goes with you. Withdrawals from an HSA that are not used for qualified medical expenses are taxed at your income tax rate, plus a 20% tax penalty. However, once you reach age 65, distributions are never subject to penalty. You can use the money for whatever you want. If you do not use it for qualified medical expenses, it will be taxable at your income tax rate. This is the same way your 401(k) or a deductible IRA would be treated for tax purposes. You may not have 25 years to save in an HSA like the worker in my previous example. Maybe you're five or 10 years away from retiring. The HSA may still make sense for you. When you reach age 55 you can contribute an additional $1,000 per year to your HSA, for a total of $7,900. If you contributed that for five years and it grew at 4% it would be worth more than $44,000. If you're five to 10 years from retirement, you still have time to benefit from using an HSA. But what about the actual health insurance part? How do the HSA and HRA compare as far as paying for medical expenses? You need to analyze what your costs would be under both the HRA and the HSA. Which plan is most cost-effective will depend on the details of your insurance plan and what your medical expenses are. Often people ask me how they can save more money for retirement. They are maxing out their 401(k)s and Roth IRAs, but want to save even more. An HSA is an often overlooked tool for this. And it's a tax savings trifecta. The money goes in pre-tax, grows tax-deferred and comes out tax free, as long as you use it for health care expenses. Want to see how much you could save in income taxes and how much your contributions could grow to? Check out these calculators. Open enrollment is a busy time and there are a lot of choices to be made. Many times, it's easier just to continue doing what you've been doing. Hopefully this article can help you take some time to consider whether the health savings account might be a good option for you. (For more, see: Pros and Cons of a Health Savings Account.) 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