Health Savings Accounts (HSA)

• Health Savings Accounts (HSA)
  • Contribution mechanism
  • Is an HDHP right for me?
  • Investing your HSA
  • HSAs as retirement vehicles
  • Last-Month Rule

HSA are intended to help those who are on High Deductible Healthcare Plans (HDHP) be able to save for large medical expenses (up to your deductible). The IRS currently defines an HDHP as the following:

	Self-only coverage	Family coverage
Minimum annual deductible	$1,650	$3,300
Maximum annual deductible and other out of pocket expenses	$8,300	$16,600

(source https://www.irs.gov/pub/irs-pdf/p969.pdf)

These accounts can be held in cash or invested. Contributions/growth can be withdrawn at any time after the account has been established for valid medical/dental expenses as defined in publication 502 of the IRS.

One key difference that catches people is that employer matches count towards your contribution limit. In 2024, the family maximum contribution is $8,550 and my employer contributes $1,500. That makes $7,050 the contribution & tax deductible space available to me, as an employee. If over age 55, there is a $1,000 catch up contribution limit increase (regardless of plan).

Contribution mechanism

HSAs can be contributed to in two fashions: direct contribution (post-tax) or via payroll contribution. There are some unfortunate differences to note when deciding how to contribute. If contributed directly (outside of payroll) you will be subject to employment taxes because the money being used to fund that contribution was taxed as ordinary income. If you contribute via payroll the contributions to your HSA are not taxable, meaning you are saving FICA (medicare & social security) and applicable income taxes (state and federal). What this effectively means is that payroll contributions to HSAs are the most optimal, as it saves FICA taxes that cannot be recovered when filing taxes. For those under the Social Security income limit ($160,200), this means 6.2% and 1.45% medicare. For those over the Social Security income limit, the tax savings of payroll contributions amounts to 1.45%, or 2.35% if you are over the threshold where additional medicare taxes are withheld.

The contribution calendar for HSA is between the 1st of the calendar year, but extends through the filing date of the same tax year. This means for 2022 contributions to HSAs can be made from Jan 1, 2022 through Apr 18, 2023. However, payroll contributions to HSAs may be restricted to just the calendar year. An example: for 2022 the HSA contribution limit was $7,200 for family plans. If $5,000 was contributed via payroll, you can additionally contribute $2,200 directly to the HSA for tax year 2022 if your payroll does not allow you to contribute to the past year. While you’ll still pay payroll taxes on that contribution, it’ll lower your taxable income by $2,200 which can be a good chunk of change!

Is an HDHP right for me?

At a high level, generally speaking, the tax savings of an HSA far outweigh the differences in premiums, and almost always make up for any out of pocket expense differences between plans available to employees assuming maximum HSA contributions by the employee.

The way I do the math is “worst case scenario” in which I don’t take into account future tax savings, look at max out of pocket for the plans available, and the premiums to cover my spouse and I. Do not forget to take into account the employer match.

tl;dr if you’re a healthy individual with relatively low recurring medical expenses or have a high income, HSA tax deductions & match can offset the cost associated with being on an HDHP.

Investing your HSA

There are two views on HSAs: a way to save for medical expenses now, or a retirement vehicle. Based on your intent for your HSA, you will want to invest it differently. For instance, if you are saving for current medical expenses and it’s a part of your overall emergency fund allocation, then you need to protect your principal. That means investing in lower risk investments such as bond funds, or even just cash.

If you are saving for retirement within your HSA, treat the HSA as a Roth IRA. It should be the riskier part of your allocation (i.e. equities) to take advantage of the fact that you can withdraw it without tax consequences for medical expenses. The more money that you can withdraw tax free, the better, right?

Caveat: New Jersey and California extract tax revenue from HSAs in varying ways, such as capital gains being realized in the HSA.

HSAs as retirement vehicles

Arguably, if you can afford to, HSAs are the best retirement vehicle made available to investors. They allow for tax deductible contributions (regardless of income level except for California and New Jersey, where state income is levied), tax free growth (growth can be withdrawn tax free if used for valid medical expenses), and tax free withdrawals (valid medical expenses). This combines the power of Roth & Traditional in a single account.

In addition to this, you can reimburse any valid medical expenses incurred after the establishment of the account. This means that you can “bank” unreimbursed medical expenses leading into retirement, allowing your balance to grow, and withdraw the balance of your medical expenses incurred.

This is a huge benefit as you would otherwise pay early withdrawal penalties on Roth accounts before 59.5, or have to pay income taxes on (and penalties) on traditional accounts. For those who are planning on retiring before the 59.5 mark, this vehicle may be a great way to span the gap between retirement age and 59.5 when early withdrawal penalties cease to be a limiting factor to accessing your other retirement accounts.

In addition to all of this, at 65 an HSA has the restrictions on medical expenses lifted and the withdrawals just become taxed as income, similar to a traditional IRA.

Last-Month Rule

HSAs have a “last month” rule, in which you are considered fully eligible to contribute to your HSA as long as you meet a few criteria:

• You are on an HDHP plan that qualifies
• You are on said plan on, or before, December 1st
• You remain on a qualifying HDHP for the full calendar year subsequent to signing up for the HSA eligible plan (does not need to be the same plan, i.e. if you change employers)

If these criteria are met, you can fully maximize your HSA for the first year (remember, you can make contributions directly to your HSA outside of payroll, and up until tax filing day of the following year). For some, this could mean an additional $3,850 to $7,750 of tax advantaged space. If you fail to meet any one of the criteria, you will owe taxes on the contribution amount, in addition to a penalty.

This article has a great overview of the last-month rule.