Health Care Savings Accounts: One of the Best Accessible Tax Strategies

Introduction

Health Care Savings Accounts, or HSAs, are a great tool for savings come tax season and ensuring you're prepared to meet unexpected medical expenses. This is my first year of participation but I'm kicking myself for now opening an account sooner. With an HSA, you're able to contribute pre-tax $3,850 and $7,750 for individuals and households respectively, for the 2023 tax year. In 2024, those amounts increase to $4,150 for individuals and $8,300 for households.

What excites me about this program is the inevitability of health care expenses. Almost certainly, there will come a time when you or someone in your care will experience medical necessity incurring significant expense. Why not reduce the burden of this expense by your marginal tax rate?

But not everyone qualifies.

Requirements

What does it take to qualify for an HSA? 

• You are covered under a high deductible health plan (HDHP), described later, on the first day of the month.
• You have no other health coverage except what is permitted under Other health coverage, later.
• You aren't enrolled in Medicare.
• You can't be claimed as a dependent on someone else's 2023 tax return.

IRS Pub 969 (Accessed 2023)

So basically, you need a high deductible health plan, which as of 2023 the IRS defines as a deductible of $1,500 for individuals and $3,000 for families, you can't have any other health coverage apart from a few exceptions, you can't be enrolled in Medicare, and you can't be a dependent.

I've known about HSAs for some time but what kept me away was the HDHP requirement. Without researching more thoroughly, I assumed my PPO didn't qualify and that the thresholds were too high to be practical. It turns out the deductible ceiling was lower than I expected at just $1,500 for an individual. If your health insurance is provided by your employer, it's likely your deductible is lower than this amount. But still, it's worth a check.

If you're providing your own health insurance, self-employed etc., you may be surprised at how high your deductible is. Lowering your deductible that little bit more can have an outsized effect on your premiums. Even if your deductible doesn't qualify, it may be worth restructuring your insurance if you're young and healthy. The IRS refers you to the last-month rule for determining your plan's eligibility:

Under the last-month rule, you are considered to be an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers) and you meet certain other requirements.

So you have until essentially the end of November to make a change that will affect your entire tax year. This is pretty generous in my opinion and I think you'll see that's a recurring theme with this program.

Rollover

A great feature of the HSA is the ability to rollover funds to the next period without consequence. Whereas the sister vehicle, the Flexible Spending Account (FSA), is a use it or lose it account, the HSA doesn't require you do spend your contributions within the tax year. Additionally, the amounts that 'rollover' don't count against the next period's contributions. You're able to continuously accumulate contributions through time and allow those funds to grow tax free.

What's an HSA for Anyways?

In my opinion, the single-best way to use your HSA is on copays. While many of your out-of-pocket medical expenses are tax deductible normally, these expenses must cumulatively exceed 7.5% of your adjusted gross income for the year according to IRS Topic no. 502, Medical and dental expenses. Depending on your income level, this could be a high hurdle to overcome and those expenses amounting to less than this threshold will be excluded. Using your HSA to cover copays allows you to immediately capture a tax benefit.

Other items I've been using my HSA for include chiropractic and dental care. Expenses like these are often not covered by health insurance or it's cost prohibitive to include them in a plan. Considering that cash patients generally receive a discount for care, using your HSA that is further discounted by your marginal tax rate since you're using pre-tax dollars, is an efficient approach to covering these expenses.

There are some exceptions. For example, personal use items like toothbrushes or other household items are excluded from eligibility.

For more guidance on what is and isn't covered, refer to IRS Pub 502. HSA providers often provide publications and other guidance on what does and doesn't qualify for your HSA.

Which HSA Account Provider?

There are a number of financial services providers out there. For my purposes, I chose Fidelity. In my 30's at the time on this writing, I have a modest actuarial runway to grow my HSA. Therefore, I'm interested in allocating contributions to long-term investments like index funds. Even without allocation to long-term assets, the money market sweep that Fidelity offers for your excess cash balances is great. Currently, I'm earning around 5% at the time of publication. To access return such as this without any effort is a plus since I don't always wish to log in and administer my account. 

Additionally, Fidelity offered a debit card to make withdrawals easier when using your HSA for a qualified expense. I suspect most if not all HSA providers offer a debit card. However, the HSA is a lesser-known product and I find comfort in using a recognizable provider when I present my card for payment.

Don't Miss Out

If you're just now sitting down to file your tax return you're probably thinking the opportunity has passed. Not so for HSAs. The IRS allows you to contribute the annual maximum up to April 15 for the prior tax year.

Whereas much of your tax strategy needs to take place within the actual tax period, here we have a great tax shield opportunity that you're able to opt in to in the final hour. For example, if you're currently filing for your 2023 tax year and the current date is April 15, 2024, you're eligible to open an account, fund, and have those contributions applied to your 2023 filing so long as you meet program requirements.

Final Thoughts

Tax planning can be difficult. Certain income types can be difficult to shield and some approaches can be perceived by the IRS to be more aggressive than others. In contrast the HSA is low hanging fruit. Evidently, this is a program that the government is strongly encouraging you to participate in. You're able to take pre-tax dollars, grow your funds with investment, and spend your accumulated capital on qualified medical expenses. It's just a matter of time until you'll need to spend on your healthcare. Why not take a sizable discount today and rest well knowing you're prepared for an emergency?

**The information presented here is intended for informational purposes only and is not tax advice. Consult a tax professional and/or IRS materials.