Is a Health Savings Account Worth the Tax Break?

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A health savings account (HSA) offers impressive tax benefits that go beyond medical expenses. Depending on your situation and financial goals, it can be a great way to minimize your health costs and even save for retirement.

However, an HSA may not be the best option for some people, particularly those with significant healthcare needs or who are on a tight budget. Here are some things to consider to determine whether an HSA can work for you.

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Health Savings Account Tax Benefits

HSAs offer what experts refer to as a triple tax advantage. Here's how it works:

• Contributions are tax-deductible: You can deduct any contributions you make to a qualified HSA on your federal tax return, up to a maximum of $4,150 for self-coverage or $8,300 for family coverage in 2024. In most states, you also won't pay state income taxes on your HSA contributions.
• Earnings grow tax-free: You can invest your HSA funds, and your earnings will grow tax-free.
• Qualified withdrawals aren't taxed: When you withdraw money from an HSA for qualified medical expenses, such as office visits, prescriptions, and certain equipment, you can do so without incurring a tax bill.

Note, however, that non-qualified distributions are typically subject not only to your ordinary income tax rate but also a 20% penalty.

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Health Savings Account Retirement Benefit

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While an HSA is primarily designed to help defray the cost of medical care, you can also use it to supplement your retirement savings. Healthcare may become one of your more significant expenses as you get older, and having tax-free dollars to cover those costs can make a huge difference.

What's more, once you reach the age of 65, you'll no longer be subject to the 20% penalty on non-qualified distributions — though you'll still need to pay your ordinary income tax rate.

Health Savings Account Costs

In addition to the costs of managing an HSA, you'll also need to consider the costs of having a qualified health insurance plan and the costs of ongoing medical care under that plan.

HSA Plan Costs

Management fees for an HSA depend on which financial institution you use. In most cases, you can expect to pay less than $5 per month, and some don't charge a monthly fee at all, especially if you meet certain balance requirements.

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Health Plan Premiums

To qualify for an HSA, you need to have an eligible high-deductible health plan (HDHP). To qualify as an HDHP, a plan must have a minimum deductible of $1,600 for self-coverage or $3,200 for families, as well as an out-of-pocket maximum of no more than $8,050 for self-coverage or $16,100 for families.

HDHPs tend to be the cheapest health insurance option because they don't offer much coverage until you reach your annual deductible.

According to the Kaiser Family Foundation, here are the 2023 average monthly employee contributions for a high-deductible health plan compared to a preferred provider organization (PPO) plan, which is the most popular form of health insurance:

Ongoing Medical Expenses

HDHPs are cheaper than other health insurance plans because they may not offer copays for office visits and prescriptions — you may be required to pay for everything beyond preventive care out of pocket until you hit your deductible.

To get an idea of what the cost difference could be for you, take a look at your claims from the last year or so.

For example, if you visited the doctor five times in the past year, and you have a $45 copay for office visits, that's $225 in copays. If you have an HDHP, and your doctor charges $110 per visit, that's $550 over the course of a year.

Is a Health Savings Account Right for You?

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Ultimately, the question of whether an HSA works for you depends on your situation. Here are a couple of simple examples to consider.

Example 1

Let's say you're single and relatively healthy, and you can max out the self-coverage contribution limit of $4,150. Your effective tax rate is 15%. Here are some potential figures:

In this scenario, having an HSA can be a great way to sock away some money for future healthcare needs and take advantage of some great tax perks.

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Example 2

If you, a spouse, or a child have significant — or less predictable — medical needs, or you don't have a lot of money to spare each month, you may not be able to fully take advantage of an HSA's benefits.

In this scenario, let's say you can only afford to contribute $5,000 toward your family HSA, and you have a 20% effective tax rate:

Even with the HSA's tax break, having an HDHP plan in this scenario would be more costly than sticking with a PPO.

Determine if an HSA Is Right for You

To determine whether an HSA is right for you, take a look at your financial situation. Some things to consider include your estimated medical expenses for the year, the amount you can reasonably contribute to an HSA, and your estimated effective income tax rate.

To get an idea of what these might look like, review your budget, tax return, and medical expenses for the previous year.

Once you've run the numbers, you can make an educated decision about how to proceed.