The Power of a Health Savings Account
On this week’s podcast episode sponsored by HPSO, Tim Church joins Tim Ulbrich to talk about the ins and outs of a Health Savings Account, how an HSA fits into a financial plan and why he is choosing not to use his HSA to pay for medical expenses.
Summary
A health savings account (HSA) is an account that allows someone to contribute to it on a pre-tax basis to pay for qualified medical expenses. Unlike a FSA, any amount you contribute to it is yours and you aren’t forced to spend it within a year. If you have a high deductible health plan (HDHP) that has a deductible of $1,400 for an individual and $2,800 for a family, you can qualify for an HSA.
Tim Church explains that an HSA is not a health plan per se, but instead is a benefit that unlocks if you have the option to have a high deductible health plan. For 2020, HSA contribution limits are $3,550 for an individual and $7,100 for a family. A catch-up contribution of $1,000 is available for those that are over age 55.
Tim shares that HSAs have triple tax benefits: your contributions will lower your AGI, any contributions grow tax free, and distributions are tax free. The caveat with the last benefit is that if you’re under 65, these distributions must be used for qualified medical expenses. Otherise, you’ll pay a 20% penalty and will be taxed according to the marginal rate. After age 65, any distributions don’t have to be for qualified medical expenses, however you’ll have to pay income tax if they aren’t.
Tim explains that the most power in an HSA comes from this loophole: you don’t have to reimburse yourself in the same year you incur medical costs. This means that you’re able to allow your money to grow in the HSA and reimburse yourself for the medical expenses later on in life as long as you have the receipts and are keeping good records. Tim is essentially using his HSA like a 401(k) or TSP account, meaning he’s aggressively investing it in stock index funds and is using it like a retirement account instead of a savings account for medical expenses.
Mentioned on the Show
- Get Professional Liability Insurance with HPSO
- YFP 019: How do Health Savings Accounts (HSA) Fit Into a Financial Plan?
- YFP 073: How to Determine the Priority of Investing
- YFP 163: Investing Beyond the 401k/403b
- Why I’m Not Using My Health Savings Account to Pay for Medical Expenses
- High Deductible Health Plan (HDHP) Limits
- YFP Planning – Comprehensive Financial Planning Services for Pharmacists
- YFP Facebook Group
Episode Transcript
Tim Ulbrich: Tim Church, two weeks in a row. Welcome back to the show.
Tim Church: Always good to be on. And you could also call this episode, “One of Tim Church’s Biggest Financial Mistakes Ever.”
Tim Ulbrich: I mean, how many episodes have we discussed the context of the topic as it relates to our mistakes? So here’s another one, which we will jump into in more detail. So today, we’re talking all about using an HSA as a savings vehicle. Now we talked a bit about HSAs on the podcast in the past, specifically Episode 019, How Does an HSA Fit Into a Financial Plan?, Episode 073, How to Determine the Priority of Investing, and most recently, on Episode 163, we briefly HSAs as it relates to Investing Beyond the 401k and 403b. But when I saw you wrote a blog post for the YFP blog on HSAs, I was reminded how powerful these accounts can be if you have access to them and knew we had to dig in more and dig in further on this topic. Now, for some of you listening, you may already saving in an HSA, some of you may have no idea what we’re talking about or this is the first time you’re hearing of it. And some of you may not have access to an HSA currently. And that’s OK as you may have this option available to you in the future. So Tim Church, let’s start with the basics: What the heck is an HSA?
Tim Church: So HSA stands for Health Savings Account. But the name itself is a little bit of a misnomer, as we’ll unpack, because you really can use it as more of an investing vehicle than necessarily just a simple savings account. But essentially, it allows you to contribute money on a pre-tax basis to pay for qualified medical expenses. These include costs for deductibles, copayments, coinsurance, and other expenses, generally not premiums, but a lot of different things that would fall under that as a qualified medical expense. And one of the biggest things — and I see this confusion come up a lot — is unlike an FSA or a Flexible Savings Account, any amount that you contribute into this is yours and you’re not forced to spend it every year. So it’s not a use-it-or-lose-it situation. Basically, those funds are there until you use them, even if you change jobs. It doesn’t matter. It’s going to follow with you, so it’s portable. So even if that’s the situation, it’s something that you’re going to continue to be able to utilize.
Tim Ulbrich: So key difference there, Tim: FSA/HSA. FSA you lose it if you don’t use, so you get some of the tax benefits, of course, that are associated with an FSA, but you’re always kind of worried about, OK, how much do I need? Am I going to need it? What if I don’t need it? HSA, totally different, right, in terms of if you decide to contribute or even max this out, you’re going to be able to continue to let those funds roll over, and we’ll talk about the growth opportunities that can come from those long term. So what is an HSA exactly? I mean, beyond what you just mentioned there, in terms of the setup of the accounts and how these worked and who ultimately has access to them.
Tim Church: So a Health Savings Account is not a health plan per se but rather a benefit that you unlock if you opt into a specific kind of health insurance plan called a high deductible health plan, or an HDHP. And these plans, as defined by the IRS, are those with deductibles of at least $1,400 for an individual and $2,800 for a family. Now that’s as per 2020. And these change over the years.
Tim Ulbrich: So we’ll link in the show notes to the IRS numbers if folks want to take a look at that further. But just to reiterate what you had said there, you essentially have to be enrolled in a high deductible health plan, so folks need to be thinking about not only can they contribute to the HSA if they’re eligible but also what’s their plan to be able to fund and bank the deductible monies in the event that they would need to use them throughout the year. So obviously coming into play here would be the emergency fund. So Tim, what from your experience — before we talk about contribution limits — from your experience, how widely available, in talking with many pharmacists, how widely available are these? And is this something that you’re seeing grow each and every year?
Tim Church: I think a lot of people have access to some form of a high deductible health plan. Not all of them are always that great. But I think that they are becoming more available. For me, I had this available for several years, even when I first started working, but just really didn’t understand what it was and how it worked and really was persuaded into a traditional PPO plan where everything was basically covered. If I had to go in for an appointment, covered medications, but the reality and the biggest thing that I didn’t understand is that with those traditional health plans, the premiums were much higher. And for somebody like myself who’s been fairly healthy, even though I’m not paying for things as they come up, they’re coming out of my paycheck, so I’m paying more for health-related expenses that I may not actually incur and didn’t incur for the first couple years when I was working. So that’s one of the biggest distinctions is that a high deductible plan is that you’re going to have to pay out of pocket for things that come up until you hit your deductible. But in general, your premiums are going to be lower.
Tim Ulbrich: Yeah, and I think that’s the mistake you had referenced earlier, which I think thankfully is not a catastrophic one, right? But is worth noting for folks that may be in a similar position. If you’re healthy and otherwise don’t have a lot of healthcare expenses, obviously you never know what the future is going to hold, but if you’ve got a good emergency fund and there’s a stark difference between the premiums in more of a traditional plan versus a high deductible health plan, you could fund the deductible if something were to happen, well then obviously being able to go into the high deductible health plan not only unlocks perhaps the HSA but also is going to free up monies each and every month that you could allocate towards another part of your financial plan. So Tim, as we talk about HSAs here, what are we referring to as contribution limits? Because I think this is important as folks are considering OK, I know how much I can put in a 401k or 403b, we’ve talked about that many times on the show. I know what I can do in a Roth IRA or a traditional IRA. And here, if we’re going to begin to think about an HSA perhaps not only for health care expenses but as a long term savings account, it’s important we have an understanding of how much we can allocate towards that. So what’s the dollar amounts we’re looking at in 2020 for contributions?
Tim Church: So similar to an IRA or a 401k, these contribution limits change every couple years. For 2020, for a self high deductible health plan, you can contribute up to $3,550. And for a self plus one or family, that number is $7,100. And then there’s also a catch-up contribution of an additional $1,000 for those who are 55 and older.
Tim Ulbrich: And Tim, I want to go back. One thing you had mentioned when I asked you how widely available these are, you said I think lots of people may have access to them or certainly they’re growing in the number that are available. But you had mentioned not all of them may be good. And what were you referring to there? Is it in terms of the construct, design of the plan? The investment options that are available? What are you referring to there when you talked about the quality of the plan?
Tim Church: So Tim, I think there’s a couple things to consider when you’re looking at those plans. And one is what the deductible is set at because if it’s something that’s very, very high, that means you’re going to be paying a lot of money out of pocket until you reach that level. I’ll give you an example for my high deductible health plan. For my wife and myself, our deductible is set at $3,000, meaning that health expense that comes up, we have to essentially pay for it out of pocket until we reach that $3,000 mark. And then from that point until about $6,800, that’s when our insurance would kick in and we would have a copayment. But the one thing that we like about our plan is that you’re out-of-pocket expenses cannot exceed a certain level. And so the IRS sets that. For individuals, that’s $6,900 and $13,800 for in-network services. And that’s something to take into consideration as well because that may also be a benefit if you look at you’re never going to pay in a given year over a certain amount, that can be very helpful and beneficial. But if the deductible is set very, very high, that means anything that comes up, you’re on the hook for paying those. I think the other thing to look at is what are your typical needs that you’re going to have in a year for whatever medical conditions you have for medications? So you always have to look at what those additional coverage options are going to be versus what you would get in a traditional plan. And then I think the other thing to consider is when you are going to go with one of these high deductible health plans is picking a trustee or somebody who’s going to administer the HSA that is going to offer good investment options if that’s the route that you’re going to go. And when I say good investment options, meaning you have a diverse number of options available but then also ones that have low fees associated with those funds.
Tim Ulbrich: Love it. Great summary. And I think that aligns so well with what we talk about in terms of investing philosophy with our comprehensive financial planning services. You want to have options, right, where you can have choice but also be able to keep those fees low because as we’ve talked about on the show, we know how those fees can eat into your long term savings. So if you’re putting the money in, we want to do everything we can to minimize what’s ultimately eating away at those funds. So let’s dig into the HSA more. And to be honest, this is where not only does it get good, but this is also where I start getting a little bit of FOMO because I don’t have access to an HSA so every time we’ve talked about it, I mentioned previous episodes, I’m always like, man, I wish I could do this as it relates to my financial plan. And our listeners have likely heard us talk or perhaps somebody else talk before about how an HSA has what’s referred to as the triple tax benefit. So Tim, break that down for us. What is the triple tax benefit? And spend a little bit of time on each one of those areas.
Tim Church: Sure. So the first one is that contributions that you make towards a Health Savings Account will lower your Adjusted Gross Income. So I think as pharmacists, one of the things that’s sort of annoying is that there’s a number of deductions that are available, but I often find myself, well, you make too much money to qualify for that. You can’t deduct student loan interest because you make too much. You can’t deduct traditional IRA contributions. Well, that’s one of the biggest benefits of an HSA is that it doesn’t matter how much money you make, that anything you contribute will lower your Adjusted Gross Income, which I think is huge. So that’s one of the things that I would often tell my colleagues is that look beyond the difference in cost in what you’re going to pay with your health insurance is that you have to look for other ways to lower your tax liability. And even though this may not be huge, depending on if you’re an individual versus a family, it still can be a pretty significant amount. So that’s No. 1. No. 2 is that any contributions you make to the HSA, whether they’re in investment accounts or some bond account or a high yield savings account within that is that those contributions are growing tax-free, which is also a really big deal.
Tim Ulbrich: Absolutely.
Tim Church: So like I said, whether you invest or you simply save them, they’re going to — if there’s growth on any of those accounts, you’re not on the hook for paying any taxes on those gains. And again, this is where it really comes down to how you want your HSA to function. So there’s a lot of people who are going to have medical expenses that they’re going to incur throughout the year, and they may want to use their HSA to pay for those expenses on a pre-tax basis, which is fine. I mean, there’s nothing wrong with that. You’re still getting the savings by paying for those expenses in that way or reimbursing yourself. But the power of the HSA is really where you can essentially pay out of pocket for health expenses that you may incur through the year and any of those contributions you make to an HSA, you can really look at it as almost an IRA. I know Dr. James Dowley at the White Coat Investor, he calls the HSA a “Stealth IRA” or an “IRA in disguise,” which really, that’s how it can function if that’s the way you want it to be. So that’s really powerful when you look at the ability to get growth and those investments in the HSA to grow over time and not have to worry about paying taxes on those gains.
Tim Ulbrich: And Tim, just real quick there, you’re essentially then looking at this, potentially, if you don’t have to use it for health care expenses, you’re looking at this as another long-term savings, another retirement account, correct?
Tim Church: Exactly. I mean, that’s exactly how ours is functioning right now. So I’ve had it set up now for three years since we changed our health insurance plan to a high deductible plan, and essentially everything we’ve been contributing in there I’ve just basically focused on that it’s an investment, it’s for retirement, and I’m not using any of the money in there.
Tim Ulbrich: Awesome. Awesome. So No. 1 was contributions lower your Adjusted Gross Income, your AGI. No. 2 was your contributions can grow tax-free. So these two both sound awesome. So give us the third, the good news to wrap it up.
Tim Church: So the icing — yeah, the icing on the cake is that the distributions are tax-free. And I’ll put a little asterisk there.
Tim Ulbrich: Ding ding!
Tim Church: Because there’s a couple things with that. But in general, there is a way you can take money out and not have to pay any taxes on it. So first off, if you’re under 65, the distributions you make have to be for a qualified medical expense. Otherwise you have to pay a 20% penalty, and you get taxed according to your marginal rate. So definitely not something that you want to do. But after age 65, any distributions, they don’t have to be for a qualified medical expense, but you have to pay income taxes if they’re not. So the question then becomes, OK, well, what if I wait until I’m at the age but I still don’t want to pay taxes. Is there a way to get around this? And that’s really one of the loopholes, and this is completely legal and something to really consider, but when you’re taking distributions out of your HSA, let’s say this is 20 years down the road, 30 years down the road, you don’t have to reimburse yourself for medical expenses in the same year that you incurred them. Meaning let’s say today in 2020, I paid for medical expenses out of pocket. Well, 20-30 years from now, I can essentially say that I’m reimbursing myself for those expenses that were made several years before as long as you can prove that those are expenses that you paid for at some point in time, even if you get audited from the IRS, you’re still legally reimbursing yourself for those medical expenses. You’re just not doing it at the same time or same year that they were incurred.
Tim Ulbrich: Yeah, that’s awesome. And that detail I think is really important, one that’s not talked enough about. And just to summarize, Tim, you did a great job succinctly, but the triple tax benefit, you know, folks think of — like we’ve talked before on the show — of the benefits of say like a traditional 401k or a 403b where you’re lowering Adjusted Gross Income today but ultimately you’re going to pay taxes in the future when you pull those monies out whereas the Roth IRA, what you’re putting in today you have already been taxed on and it’s growing tax-free, and then you pull it out tax-free. This really takes the best of both of those worlds. As you mentioned, ultimately what you are putting into your contributions lower your AGI, then your contributions grow tax-free, and then distributions are tax-free with the important stipulations that you mentioned. So talk to us about how you approach this, Tim, with your HSA. And again, this isn’t investment advice, of course. You know, we know every personal situation is different. But I think it would be helpful for our listeners to hear how do you approach your HSA in terms of aggressive, conservative, is this the place you’re really leaning in? Or are you looking at other places to do that and you’re a little bit more conservative here? How do you look at the investment strategy when it comes to your HSA?
Tim Church: Yeah, I mean, really it’s just similar to my 401k, which is through the government, it’s a TSP or a Thrift Savings Plan. That basically is very aggressive. So I don’t plan on using —
Tim Ulbrich: Full throttle, Tim Church-style, full throttle.
Tim Church: Take it to the limit. So it’s super aggressive into stock index funds because I’m not planning on using any of the money for several years down the road. And so it really is — the way I’m viewing this is I’m not touching it, I’m not going to use it for medical expenses today. Even if later down the road — you know, some people have said, let’s say you get to age 65 but you have so much money in your HSA that you haven’t even incurred that amount in medical expenses. Well, No. 1, that’s pretty awesome because that means I’ve been pretty healthy, my family’s been healthy during those years. But No. 2, the worst case scenario is you don’t pay a penalty but you pay income taxes on that. So it’s still a good option, even if that were the case. But yeah, it’s very aggressive. I’m viewing it as a retirement account, I’m not thinking about using it today or even in the next year. So it’s a very aggressive strategy. And like I said, that’s where it’s kind of a misnomer when you heard the word Health Savings Account because within my particular plan, there are several aggressive investments where you can put the majority of your money, all of your money if you want to, in a very aggressive portfolio in order to achieve greater gains several years down the road. And so for us, that’s the way we’re looking at that. And that’s why we’ve made that a huge priority after getting our matches at our work that that’s basically step No. 2 because of all of those tax benefits, this is very high in our priority with looking at those accounts.
Tim Ulbrich: Yeah, and again, just to reinforce a point you made earlier to our listeners that just like we say, not every 401k or 403b is created equal in terms of your investment choices and fees, the same thing is true with HSAs. So you know, we’re obviously talking about this at a high level and globally talking about the tax benefits, but ultimately the construct of the high deductible health plan and where that deductible is set as well as your savings options within the HSA and the fees associated with those is going to make this — I would say on the spectrum of attractive because I think regardless, it’s still attractive, but more or less on that higher end of attractive. So Tim, you just alluded to this, but I don’t want to have anybody overlook it. You mentioned where this fits in priority-wise, but I want to dig into that a little bit further because I think we spend so much time talking about some of the, you know, more popular I guess you would say, 401k, 403b’s, Roth IRAs, brokerage accounts, etc. And HSAs sometimes gets lost in the mix of looking at this as an investing vehicle because of its name, Health Savings, as well as how it’s often used. But to reiterate what you just said there, we’ve talked about this before when we talked about priority of investing on Episode 073, where do you see this fitting in to one’s investing plan? Again, generally speaking.
Tim Church: Yeah, so this is really Step 2 for us after the match through our employer. Through my wife’s, she has a 401k match and I do as well. And really, after that, the HSA was Step No. 2. Just because of all those benefits that we outlined. And you know, for us, even when we were paying off student loans, we were getting our matches at work and we were going all-in on the HSA. And for us, we just didn’t want to miss out on those benefits of the years being able to contribute to that. So that’s something that we did, even in tandem while paying off student loans. Now I’ll say one thing that’s really cool is that if you are a person doing PSLF, so the Public Service Loan Forgiveness program or even a forgiveness after 20-25 years, that’s something that’s really cool beyond putting money in a traditional 401k, as we talked about, your contributions to an HSA are lowering your AGI, which are ultimately going to lower your student loan payments that you have to make. So again, you’re growing investments while you’re lowering your student loan payment. So it’s a really cool benefit for those who are pursuing forgiveness.
Tim Ulbrich: Love it. And Tim, one of the questions I saw come up recently in the YFP Facebook group, you know, I think somebody was asking essentially, hey, I would love to be able to take advantage of my employer’s HSA. I’m not currently in a high deductible health plan, but I’d like to make that switch so I can unlock that option. What are you seeing out there — and I know this could differ from one employer to the next for folks that might be listening here in August, it’s not open enrollment yet, do they have to wait if this option is available? Are there triggering events that may open up that door for somebody? What advice would you have for folks that are hearing this and saying, “I want to jump on this.”
Tim Church: Yeah, usually you can’t until it’s open enrollment unless there’s a qualified life event. Usually that’s birth of a child, marriage, what are some of the others? What are some of the other ones I’m missing, Tim?
Tim Ulbrich: We actually just — you mentioned marriage, birth of a child are the big that I can think off the top of my head. Somebody in the group actually mentioned there after consulting with their HR, their employer had considered COVID-19 as an event that allowed them to make changes. So that may be some unique circumstance like that. But the two that you mentioned are the two biggest ones.
Tim Church: And the other thing I think that’s important to look at is a lot of people are very nervous about switching to a high deductible plan knowing that they’re going to have to shell out quite a bit of money in the event that they have medical expenses come up. So you briefly mentioned it, having that emergency fund is really important if you’re going to make that switch because you have to be ready to put out quite a bit of money until you reach that deductible. So I think that was really key. The other thing, what is a cool benefit is that a lot of health insurance plans is that when you enroll in a high deductible plan, they actually give you money every year that directly goes toward your contribution limit for your HSA. So for example, the plan that we have through the federal government, they actually give us $1,500 every year just for being in the plan towards the HSA, which is a huge benefit. So when you add that up to the savings in the premiums, as long as I’m fairly healthy, it tends to be a much better situation in terms of costs. Obviously the difference is going to vary between a traditional plan, depending on how much you utilize medical services in a given year. But again, the only way to even unlock the HSA is to be in a high deductible plan anyway.
Tim Ulbrich: Great stuff, Tim. And a really succinct but good overall summary of not only what is the HSA but how you have viewed it in your personal financial plan. And I would remind our listeners, as always, if you want to look at the show notes for this episode, you can go to YourFinancialPharmacist.com/podcast, pull up the episode, and you can get a link to not only a transcription of this episode but also other resources that we mentioned during this episode.
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