close up of female making calculations

A powerful tool

Many employers offer Health Savings Accounts (HSAs) for employees who select a high-deductible health care plan. These accounts offer a powerful method to invest continually and strategically grow assets to fund health care expenses in the future.  

Triple tax benefit

HSAs offer an incredibly tax-efficient method to build reserves by delivering a rare “triple tax benefit.”

  • Contributions are made on a pretax basis, potentially reducing current taxable income
  • Investments grow tax-free for qualifying withdrawals for health care
  • Withdrawals for qualified health care expenses are made tax-free

A long-term approach

While many employees use these accounts to fund their current-year expenses, their real value comes as an investment vehicle for the future.

Unlike flexible spending accounts, HSAs permit owners to carry balances across calendar years and invest the assets. By paying for current health care expenses out-of-pocket instead, investors are able to invest and grow balances, building significant resources for the future.

By consistently contributing the maximum annual amount, and investing the balance for future health care costs, one can accumulate a nice tax-free reserve to fund future health care costs. For example, an investment of just $100 per month over 20 years can turn $24,000 into over $56,000 (assumes a 8.0 percent rate of return).  

Limits and restrictions

HSAs have contribution limits that are periodically adjusted by the IRS. For 2018, you are able to contribute up to $3,450 for an individual or $6,900 for a family. Like most retirement accounts, there is also a catch-up contribution. Individuals age 55 and older can contribute an additional $1,000, putting the total family contribution at $7,900 for families with one member age 55 or older.1

As Medicare is not considered a high deductible plan, qualified contributions end with Medicare enrollment. Couples with an age difference can continue to contribute to an HSA as long as one spouse is still HSA eligible and not enrolled in Medicare.

HSA qualifying expenses

The range of qualifying medical expenses is quite broad and includes most common health care costs. Additionally, funds may be used for insurance deductibles and premiums, dental and vision care, and even some surprising options like acupuncture and weight loss programs.

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When taking distributions from your HSA account to fund care, qualifying withdrawals are 100% tax-free. This includes both the initial contribution and any growth.

The list of qualifying expenses is expansive and includes:
  • Health or Medicare premiums
  • Hospital services
  • Insurance premiums - including long-term care and Medicare
  • Dental care
  • Medical devices
  • Mental health services
  • Doctor's visits
  • Preventive care
  • Eye exams, glasses or contact lenses
  • Hearing aids
  • Home care
  • Smoking cessation

Dependents

HSA account balances may be used to fund care for a spouse and/or dependent children. Expenses are allowed for anyone who is eligible to be listed as a dependent on the primary account holder’s tax return. Qualified medical expenses for your spouse and dependents you claim on your tax return (assuming they are also covered by your health plan) are eligible for tax-free distribution treatment. It is important to note that even though a dependent is eligible to be covered under your high deductible health plan, they may not be eligible for tax-free distributions from your HSA if they claim themselves as a dependent on their own tax return.  

Timing of payments

All qualifying expenses are eligible so long as the expenses occur after establishing the account. The balance in your account does not have to be large enough to cover the expense at the time it was incurred. In this manner a hospitalization or other large expense can be reimbursed after the fact if an account balance is run to zero but is still being funded.  

Funding your HSA

Salary deferral

Contributions to your account may be made by pretax salary deferral. This can be set up during your annual enrollment period as a simple way to begin to invest pretax dollars.

Direct contributions

Additional and ongoing contributions may be at any time outside of salary deferral and in most cases may be deducted from taxable income.

Employee incentives

Many employers offer incentives in the form of direct payments to an HSA to encourage participation in health and wellness programming.

IRA rollover

Your account may also be funded via a one-time tax-free rollover from an IRA. The amount to rollover is limited by annual contribution limits, but this can serve as an effective way to jump-start investing.

Age 65 and beyond

Following Medicare enrollment, you are no longer eligible to contribute to an HSA, but may continue to fund your care with HSA dollars, including paying for long-term care and Medicare premiums.

For added flexibility, seniors are allowed withdrawals from their account for nonqualifying expenses after age 65. These are available without a penalty but will trigger normal income tax.  

Catching up after a late start

Even with the late start, a 50-year-old can build a meaningful reserve within an HSA prior to Medicare enrollment.

When the maximum amount is invested each year, balances can grow to over $200,000 in the 15 years prior to Medicare eligibility.

$0

HSA balance at age 50

+

Maximum contributions
($6,900 annually)

+

Catch-up contributions beginning at
age 55 ($1,000 annually)

+

Investment growth

=

$200,000

Balance at age 65

This projection is helped by investment growth of 5.5%

Unused balance

If an account holder passes away prior to exhausting the balance in their HSA, the surviving spouse is eligible to inherit the account. They may continue to use the balance of the account with the same benefits and restrictions as the account holder. However, if passed on to a nonspousal beneficiary, the benefits will be subject to tax.  

Take action
  • Review your benefit elections annually, using online tools to project cost
  • Consider saving in an HSA and systematically saving the maximum contribution over time to build flexibility for the future
  • Leverage the power of time to boister your resources across all your employee benefits

Read more from our RBC Wealth Insights report Taking control of health care in retirement

1. Rev. Proc. 2017-37: Tax forms and instructions, IRS.gov, 2017.