Health Saving Accounts: An Underutilized Opportunity in a Time of Uncertain Healthcare Changes

by Dickinson Wright

Regardless of whether there will be revisions to, repeal of, or no changes at all to the Affordable Care Act, patients will most likely continue to have a larger financial responsibility for their medical care.  This is true whether the insurance is provided through an employer, purchased individually, or offered through Medicare, all of which will likely continue to pass to their beneficiaries higher deductibles and co-pays that must be paid by the individuals when receiving care.  

A health savings account (HSA) offers individuals participating in high-deductible health insurance plans (currently a deductible of $1,300 for an individual, and a deductible of $2,600 for a family) the opportunity to save pretax dollars and use these funds tax-free to pay for qualified medical expenses.  While Medicare beneficiaries cannot contribute to an HSA, funds saved prior to enrolling in Medicare can be used for Medicare expenses in retirement. Unused funds rolling over from year to year and can be invested similar to a 401(k).  

While Health Savings Accounts have been around since 2004, and are gaining in popularity, they are still significantly underutilized by eligible individuals. In 2016, only 20 million individuals (less than 10% of the population) were enrolled in an HSA, only a 3.4% increase from the prior year. In addition, at the end of 2015 the average HSA balance was only $1,844, with individuals under 25 averaging only $759 and individuals over 65 averaging $3,623 in savings. This low amount of savings is staggering given estimates of healthcare expenses in retirement, which can exceed $250,000.  

The low utilization also demonstrates a significant missed opportunity for not only planning for future healthcare expenses but also tax savings which could significantly increase resources available in retirement. HSAs provide an unusual triple tax advantage of allowing a tax deduction upon contribution, deferred taxes on growth of the investment in the plan, and a tax free withdrawal for qualifying healthcare expenses.  Most tax deferred savings programs provide for only two of these three benefits.  For example a 401(k) or an IRA allow for a tax deduction on contributions and deferred taxes on growth, but distributions from the plan are taxed. Roth IRAs require after tax contributions, but allow for growth and distributions tax free.   

As an additional benefit, HSA’s allow for distributions to cover non-medical expenses after age 65 without a penalty.  The funds distributed will receive a similar tax treatment to a 401(k) or IRA, i.e. taxed on distributions. As a result, an HSA can function as a back-up retirement saving plan, and can be useful to increasing tax deferred contributions when an individual’s contributions to a 401(k) or IRA have met tax deductible limits. In fact, because of the triple tax benefits and possible taxable withdraw on non-medical expenses in retirement, a good case can be made that contributions to an HSA should be maxed out prior to contributions to other retirement plans.  

Not all individuals qualify to participate in an HSA.  Individuals should consult their employee benefits representative and their tax professional to determine whether they could qualify for an HSA and any tax benefits from contribution to an HSA.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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