A Health Savings Account (HSA) can be a powerful tool for financing health care expenses while supplementing your other retirement savings vehicles, and it offers estate planning benefits to boot.
ABCs of an HSA
Similar to a traditional IRA or 401(k) plan, an HSA is a tax-advantaged savings account funded with pretax dollars. Funds can be withdrawn tax-free to pay for a wide range of qualified medical expenses. (Withdrawals for nonqualified expenses are taxable and, if you’re under 65, subject to penalties.)
An HSA must be coupled with a high-deductible health plan (HDHP). For 2022, an HDHP is a plan with a minimum deductible of $1,400 for individuals and $2,800 for family coverage, and maximum out-of-pocket expenses of $7,050 for individuals and $14,100 for family coverage.
The IRS recently issued inflation-adjusted amounts for 2023: the minimum HDHP deductible for individuals will be $1,500 and $3,000 for family coverage. The maximum HDHP out-of-pocket cost will be $7,500 for self-only coverage and $15,000 for family coverage.
Be aware that, to contribute, you must not be enrolled in Medicare or covered by any non-HDHP insurance (a spouse’s plan, for example).
For 2022, the annual contribution limit for HSAs is $3,650 for individuals and $7,300 for those with family coverage. For 2023, the HSA contribution limit for individuals will be $3,850 and $7,750 for those with family coverage.
If you’re 55 or older, you can add another $1,000 annually. Typically, contributions are made by individuals, but some employers contribute to employees’ accounts.
HSA benefits
HSAs can lower health care costs in two ways: 1) by reducing your insurance expense (HDHP premiums are substantially lower than those of other plans) and 2) by allowing you to pay qualified expenses with pretax dollars.
In addition, any funds remaining in an HSA may be carried over from year to year and invested, growing on a tax-deferred basis indefinitely. To the extent that HSA funds aren’t used to pay for qualified medical expenses, they behave much like in an IRA or a 401(k) plan.
Estate planning and your HSA
Unlike traditional IRA and 401(k) plan accounts, HSAs need not make required minimum distributions once you reach a certain age. Except for funds used to pay qualified medical expenses, the account balance continues to grow on a tax-deferred basis indefinitely, providing additional assets for your heirs. The tax implications of inheriting an HSA differ substantially depending on who receives it, so it’s important to consider your beneficiary designation.
If you name your spouse as beneficiary, the inherited HSA will be treated as his or her own HSA. That means your spouse can allow the account to continue growing and withdraw funds tax-free for his or her own qualified medical expenses.
If you name your child or someone else other than your spouse as beneficiary, the HSA terminates and your beneficiary is taxed on the account’s fair market value. It’s possible to designate your estate as beneficiary, but in most cases that’s not the best choice, because a beneficiary other than your estate can avoid taxes on qualified medical expenses paid with HSA funds within one year after death.