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Healthcare Q&A: Reform, Rules, and the Role of HSAs

Using a health savings account (HSA) is one of Laura's favorite ways to save money. She explains how they work, answers questions about HSAs from podcast listeners, and describes the important role they'll play in healthcare reform under the Trump administration.

By
Laura Adams, MBA,
February 15, 2017
Episode #485

Page 1 of 3

 Reform, Rules, and the Role of HSAsThe future of healthcare is a red-hot topic right now. President Trump and Republicans in Congress have plans to repeal and replace the Affordable Care Act, also known as Obamacare, which took effect in 2010.

While we don’t know yet what a replacement or repair plan will be, there are some proposals with interesting similarities. They include an expanded use of health savings accounts or HSAs.

In this post, I’ll explain what an HSA is and why they’re one of my favorite tools to save money. I’ll also answer several listener questions about these tax-advantaged accounts and describe the role HSAs may play in healthcare reform.  

See also: 6 Ways a Trump Presidency Could Affect Your Personal Finances

What Is a Health Savings Account (HSA)?

An HSA is a special tax-exempt account you can fund for the sole purpose of paying a variety of current and future qualified medical expenses, like doctor visits, dental cleanings, or eye exams and prescription glasses.

No matter if you get your health insurance through work or on your own, you manage an HSA as an individual. It’s portable and stays with you if you become unemployed, change jobs, or switch insurance companies.

An HSA operates like a checking account, with features like online access, automatic transfers, paper checks, and a debit card to manage and spend your money. If you forget to use your HSA for a qualified expense, you can also reimburse yourself from the account.

Some employers allow pretax contributions directly from your paycheck, and may even put in additional matching funds on your behalf. For instance, you might get $50 per paycheck or a large lump sum at the beginning of each year.

HSAs generally pay low interest rates on par with what you’d get at a bank. But many also offer investment funds, with the potential to earn more on your savings. You can transfer all or a portion of your balance into investment funds you choose from a diversified menu of options.

HSAs generally pay low interest rates on par with what you’d get at a bank. But many also offer investment funds, with the potential to earn more on your savings. 

The big deal with an HSA, and the reason I love them so much, is that you get triple tax benefits:

1.    Tax-deductible contributions – allow you to reduce your taxable income and therefore shrink the amount of tax you pay. As I mentioned, you either make pretax HSA contributions through payroll deductions (like you do with a 401k) or you claim contributions on your tax return.

For 2017, the HSA contribution limits are $3,400 if you have insurance as an individual and $6,750 if you have a family plan with at least one other person, such as a spouse or child. If you’re at least age 55, you can make an additional HSA catch-up contribution of $1,000 each year with either type of plan. These are the total limits including what you and an employer can put into an HSA.

2.    Tax-free earnings – allow you to earn interest or investment growth and skip paying tax on it. This is just like the rules for a traditional retirement account, such as a 401k or IRA, where you defer paying taxes.

3.    Tax-free withdrawals – is the biggest benefit and what makes an HSA so special. Taking money out to pay for qualified medical expenses is completely tax free. This applies to your original contributions plus any growth in your account. 

You don’t even get that deal with a traditional 401k or IRA because you do have to tax pay on withdrawals. (Roth 401k or IRA withdrawals are tax-free in retirement, but require you to pay tax upfront on contributions.) 

These are powerful benefits because they cut your tax bill and maximize your healthcare buying power. Depending on your income tax rate, using an HSA to pay for medical expenses means you could get a 20% to 30% discount. That’s serious savings!

In addition, there’s no deadline to spend your HSA money. That’s different than another type of medical savings account that you might be offered at work, called a Flexible Spending Arrangement or FSA. With an FSA, you’re required to spend all or most of your account each year, known as the use-it-or-lose-it policy.

In contrast, your HSA funds can accumulate year after year if you don’t spend them. You can make contributions at any time, even up to April 15 for the previous tax year. But you’re never required to make contributions to an HSA.

The only downside is that if you use HSA funds to pay for anything other than qualified medical expenses, the amount will be subject to income tax, plus an additional 20% penalty.

The only downside is that if you use HSA funds to pay for anything other than qualified medical expenses, the amount will be subject to income tax, plus an additional 20% penalty.

But after you reach age 65, this steep penalty disappears, which means your HSA eventually morphs into a retirement account. If you make withdrawals for non-qualified expenses, like rent or travel, they’re subject to income tax but are penalty-free, just like with a traditional 401k or IRA. So, use an HSA as an additional tool to boost your retirement savings.

See also: 10 IRA Facts Everyone Should Know

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