If the thought of paying taxes fills you with frustration (as it does for many of us), you’ll be delighted to hear the latest news from the IRS. In response to the relentless inflation experienced in recent years, the IRS has announced an unprecedented increase in the maximum contributions allowed for health savings accounts (HSAs) next year. This development is music to the ears of individuals seeking tax advantages.
For the year 2024, the maximum HSA boost by IRS and contributions have been raised to $8,300 for families and $4,150 for individuals. This marks a significant boost from the previous limits of $7,750 and $3,850 in 2023, respectively. Moreover, individuals aged 55 and above have the opportunity to contribute an additional $1,000, enabling older married couples to potentially save up to $10,300 per year, compared to the current limit of $9,750.
Decoding HSAs by IRS Understanding the Mechanics and Benefits of Health Savings Accounts
Despite being overshadowed by more prominent retirement savings accounts such as the 401(K) and individual retirement accounts (IRAs), health savings accounts (HSAs) are widely regarded as one of the most advantageous means of saving for retirement, despite their name. Surprisingly, HSAs remain underutilized by the majority of Americans, as highlighted by the Employee Benefit Research Institute (EBRI).
Health Savings Accounts (HSAs) are designed as tax-advantaged accounts aimed at assisting individuals in saving for various medical expenses, encompassing deductibles, copayments, vision care, dental treatments, hearing aids, and even long-term care. To establish an HSA, one must possess an HSA-qualified high-deductible health plan and not be enrolled in Medicare.
Contributions made to an HSA offer immediate tax deductions. For instance, if a 55-year-old couple with a household income of $100,000 and a 22% tax rate contributes the maximum amount of $10,300 in the coming year, they would save a substantial $2,266 in taxes right from the start, as revealed by Jason Bornhorst, co-founder and CEO of the benefits platform First Dollar. Bornhorst further explains that these tax savings alone could cover the expenses for most families’ vacations.
But that’s not all. Contributions made to an HSA can be invested and grow tax-free. Subsequently, withdrawals made at any age to cover qualified medical expenses are also tax-free. This “triple tax advantage” offered to HSA account holders allows individuals to stretch their healthcare funds further than they could otherwise. It surpasses the benefits of traditional and Roth 401(k)s and IRAs. Contributions in employer-sponsored 401(k)s and traditional IRAs are taxed upon withdrawal, while Roth IRA funds are taxed at the time of contribution.
Unlocking the Full Potential of Your HSA: Strategies to Maximize Benefits
To fully maximize the benefits of an HSA, individuals should focus on three key aspects: contributing the maximum amount, investing those contributions, and limiting withdrawals whenever possible to allow for compound growth. However, it is unfortunate that the majority of people tend to utilize their HSAs for immediate expenses, contribute minimally, and a relatively small percentage engage in investments, as noted by the Employee Benefit Research Institute (EBRI). In fact, EBRI estimated that only 12% of account holders diversified their HSAs by investing in assets other than cash in 2021.
To highlight the significance of investing, consider a scenario where a 30-year-old individual contributes the maximum family amount of $8,300 next year and invests it. Assuming an annual growth rate of 5% and consistent yearly contributions, by the age of 65, the HSA balance could potentially reach between $700,000 and $800,000, which can be utilized for qualified medical expenses, as suggested by Ungerott. In comparison, if the funds are left in cash with an annual return of around 1%, the balance would be approximately $350,000.
Retirement medical expenses can be substantial, with married couples potentially needing to save as much as $383,000, according to EBRI. Therefore, by maximizing contributions, making wise investments, and allowing for compound growth, individuals can better prepare for the significant healthcare costs they may face during retirement.
HSA: The Versatile Solution for Emergency Funds, Retirement Savings, and IRA Alternative
In addition to its primary purpose, savvy users have discovered additional benefits of utilizing an HSA as an emergency fund or a financial reserve. One of the unique advantages is the absence of a specific timeline for reimbursement. This allows individuals to accumulate records of medical expenses over time and subsequently withdraw HSA funds tax-free, serving as a source of emergency cash or even as spending funds upon reaching the age of 65. Ryan Losi, Executive Vice President of the accounting firm PIASCIK, highlights this flexibility, emphasizing that individuals can reimburse themselves from the HSA whenever the need arises, provided they maintain meticulous records.
While the wealthier individuals might view the HSA as a piggy bank, it’s important to note that sustaining cash flow to cover medical expenses out-of-pocket for an extended period and maintaining thorough documentation are crucial requirements. This approach allows for the accumulation of funds within the HSA.
If you are under the age of 65, it’s important to consider that withdrawals for non-qualified medical expenses will be subject to both a penalty and income tax. However, once you reach the age of 65, the penalty is waived. Consequently, the HSA essentially transforms into an IRA if you do not have qualified medical expenses. In such cases, withdrawals from the HSA are subject to ordinary income tax, similar to an IRA.
By taking advantage of the diverse functionalities of an HSA, individuals can leverage it as a versatile financial tool, serving as an emergency fund, a retirement savings vehicle, and an alternative to traditional IRAs.