Health Savings Accounts (HSA): A Tax-Advantaged Strategy with Triple Tax Benefit

A Health Savings Account (HSA) is a tax-advantaged strategy. This savings vehicle allows individuals to save for medical expenses and offers a triple tax benefit: contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are also tax-free. This powerful combination makes an HSA a valuable asset in both short-term healthcare planning and long-term holistic wealth strategies.

How an HSA Works

• Eligibility
  • Must be enrolled in a high-deductible health plan (HDHP).
  • Not enrolled in Medicare.
  • Not claimed as a dependent on someone else’s tax return.
  • No other health coverage except what is permitted under other health coverage.
  • (IRS TIP!) Married Couples: Each eligible spouse who wants an HSA must open a separate HSA. You can’t have a joint HSA.
• Contributions
  • It can be made by you, your employer, or both.
  • (IRS TIP!) 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).
• Investment Growth
  • Not subject to “use-it-or-lose-it” rules: funds roll over year after year.
  • Many HSAs offer investment options, allowing your contributions to grow tax-free, similar to a retirement account.
• Withdrawals
  • Before 65: You can withdraw funds from your HSA tax-free at any time to cover qualified medical expenses, including deductibles, copayments, prescriptions, and even certain over-the-counter medications.
  • After 65: you can use HSA funds for any purpose, although non-medical withdrawals will be taxed as ordinary income.
  • Unlike a Traditional IRA, an  HSA is not subject to Required Minimum Distributions.

 

Benefits of an HSA

1. Triple Tax Advantage: HSAs offer a rare triple tax benefit. Contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are tax-free.
2. Long-Term Savings: Unused HSA funds roll over each year, making them an excellent tool for saving for future healthcare expenses or even supplementing retirement savings. With investment options, HSAs can grow significantly over time, providing a financial cushion in your later years.
3. Flexibility in Spending: HSAs provide flexibility in how you use your funds. While they are primarily intended for healthcare expenses, the ability to withdraw funds tax-free for qualified expenses offers financial relief when medical costs arise.
4. Retirement Healthcare Planning:  Healthcare costs are a significant concern in retirement. By building up your HSA, you create a dedicated pool of funds to cover healthcare expenses in your retirement years, reducing the need to draw from other retirement accounts.
5. Portability & Ownership: Unlike other similar health savings vehicles, such as an FSA, you are the owner of the HSA. If you leave an employer, the account follows you.
6. Employer Contributions: Employer contributions may be excluded from your gross income.
7. Contribution Limits: Contribution limits vary year upon year. In 2024, the maximum contribution limits are $4,150 for individuals and $8,300 for families. If you’re 55 or older, you can contribute an additional $1,000 as a catch-up contribution.
8. Contribution Timeline: Contributions to your HSA for a specific tax year must be made by April 15 of the following tax year.

Considerations and Risks of an HSA

1. High-Deductible Requirement: To be eligible for an HSA, you must be enrolled in a high-deductible health plan (HDHP). While these plans often have lower premiums, the higher out-of-pocket costs may not be suitable for everyone.
2. Non-Medical Withdrawals: If you withdraw HSA funds for non-medical expenses before age 65, you’ll face both income tax and a 20% penalty on the amount withdrawn. After age 65, non-medical withdrawals are taxed as ordinary income but are no longer subject to the penalty.
3. Investment Risks: While investing your HSA funds can lead to significant growth, it also comes with risks. Market fluctuations can affect your account balance, and it’s essential to invest in line with your risk tolerance and financial goals.
4. Testing Period: As defined by the IRS, “if contributions were made to your HSA based on you being an eligible individual for the entire year under the last-month rule, you must remain an eligible individual during the testing period. For the last-month rule, the testing period begins with the last month of your tax year and ends on the last day of the 12th month following that month (for example, December 1, 2023, through December 31, 2024).”
5. Employer Contributions: As stated by the IRS, “You must reduce the amount you, or any other person, can contribute to your HSA by the amount of any contributions made by your employer that are excludable from your income. This includes amounts contributed to your account by your employer through a cafeteria plan.
6. Qualified Medical Expense Deductions Qualified medical expenses cannot be an itemized deduction on Schedule A (Form 1040) that are equal to the tax-free distribution from your HSA.

HSA Taxation at Death Matrix

 

HSA Beneficiary:	Spouse	Non-Spouse	Estate
Remains HSA?	Yes	No	No
Who Is Taxed?	Nobody	Beneficiary	HSA Owner (on final tax return)
Taxable Amount:	None	Full Market Value (minus medical expenses paid by beneficiaries within 1 year of owner’s death	Full Market Value

*Source: kitces.com

 

HSA vs. FSA Comparison

	HSA	FSA
You can spend the money on qualified medical expenses.	YES	YES
100% of your unused funds carry over year to year.	YES
You can invest the money for potential tax-free growth.	YES
Your contributions may be pretax.	YES	YES
Your contributions may be tax-deductible.	YES
Your account belongs to you, not your employer.	YES
Your account belongs to you, not your employer.	YES
You can contribute more for a family than an individual.	YES
You can contribute more for a family than an individual.	YES
100% of your elected amount is available on day one.		YES
You must have an HSA-eligible health plan as your only health insurance.	YES
You must be enrolled in the plan through your employer.		YES
You can use the funds for qualified medical expenses in retirement.	YES

*Source: Fidelity.com

Maximizing Your HSA Strategy

• Contribute Early and Maximize Contributions: To take full advantage of the tax benefits, aim to contribute the maximum allowable amount each year. This not only reduces your taxable income but also allows your funds to grow tax-free over time.
• Invest Wisely: If your HSA offers investment options, consider investing your funds to maximize growth potential. However, ensure that you retain enough liquid funds in the account to cover near-term medical expenses.
• Plan for Retirement Healthcare Costs: Consider your HSA as part of your broader retirement strategy. By building a substantial HSA balance, you can cover healthcare expenses in retirement without tapping into other retirement savings.
• Use HSA Funds Strategically: While it’s tempting to use your HSA funds for immediate medical expenses, allowing your balance to grow provides long-term benefits. If you can cover current expenses out of pocket, your HSA can continue to grow tax-free.
• Track all qualified medical expenses, including those paid from funds outside the HSA

 

 

DOWNLOADS

1. Will The Distribution From My HSA Be Tax And Penalty-Free?
2. Can I Make A Deductible Contribution To My HSA?

 

RESOURCES

• HEALTH SAVINGS CALCULATOR
• QUALIFIED MEDICAL EXPENSES
• HOW TO PLAN FOR RISING HEALTHCARE COSTS

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Disclosures

1. Cestia Wealth Management is not a legal tax professional. We offer tax gap analysis for clients who desire to have a comprehensive financial plan, which requires in-depth tax strategy and planning as a distinct part of the overall customized solution. Please consult your tax professional on all matters addressed in this report.
2. Wealth Mechanics™ is a registered trademark of Cestia Wealth Management. Unauthorized use of the trademark, including but not limited to commercial use, reproduction, or imitation without explicit written permission from Cestia Wealth Management, is strictly prohibited.
3. Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.
4. Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through NewEdge Advisors, LLC dba Cestia Wealth Management, a registered investment advisor and separate entity from LPL Financial.Cestia Wealth Management employs (or contracts with) individuals who may be (1) registered representatives of LPL Financial and investment adviser representatives of Cestia Wealth Management; or (2) solely investment adviser representatives of Cestia Wealth Management. Although all personnel operate their businesses under the name Cestia Wealth Management, they are each possibly subject to differing obligations and limitations and may be able to provide differing products or services.