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If you have a high-deductible health insurance plan, a health savings account can help pay your medical bills. But HSAs have hidden superpowers that make them a great way for some people to create a tax-free kitty for retirement or other long-term goals. Under the right circumstances, you can even use an HSA to help your young adult children start saving for their future.
However, not everyone is a good candidate for a high deductible health insurance policy. The minimum deductible that allows you to use an HSA is $1,400 for single coverage or $2,800 for family coverage. Many plans require you to contribute even more before coverage kicks in. If meeting the high deductible would be a struggle or require you to skimp on health care, you’re probably better off choosing a low-deductible policy and skipping an HSA.
If a high-deductible policy is right for you, you’ll need even more money to take full advantage of an HSA: enough to pay the deductible and other health care costs out of your own pocket, without touching the account. It’s a tall order, but you can still benefit from an HSA even if you have to spend some of the money along the way.
Here are the four biggest benefits of an HSA.
Superpower 1: You can benefit from a triple tax advantage
Health savings accounts offer rare triple tax relief: your contributions are tax-deductible, the money grows tax-deferred, and withdrawals aren’t taxed if you have eligible medical expenses.
In contrast, withdrawals from other tax-advantaged accounts, such as 401(k)s, are generally taxed as income. If the withdrawals are tax-free — as they can be with Roth IRAs — you didn’t get a tax break when you invested the money.
Read more: Get triple the tax benefits with an HSA and find an affordable health plan while you’re at it
Superpower 2: You don’t have to spend money
Any unspent balance in your HSA can be carried over from year to year. It is in contrast with flexible spending accounts, another tax-efficient way to pay for medical expenses. FSAs require users to spend the money within a certain time frame or those contributions are forfeited.
FSAs let you contribute $2,750 in 2021. Individuals can contribute up to $3,600 to an HSA this year, while families can contribute up to $7,200, plus there’s a catch-up contribution of $1,000 for people aged 55 and over.
HSA contributions can be invested, which means your money can really grow. Even if you have to spend some of the money along the way, the tax-free growth can add up.
Superpower 3: Any withdrawal could potentially be tax-free
As mentioned, withdrawals are tax-free if used for eligible medical expenses, including health insurance deductibles and co-payments. The IRS maintains a list of eligible expenses ranging from acupuncture to X-rays. You cannot stack deductions: only qualifying expenses that have not been reimbursed by another source, such as insurance or a flexible spending account, can qualify for a tax-free withdrawal. ‘tax.
The key thing to know, however, is that the IRS does not require you to incur the expense in the year you make the withdrawal.
As long as the expense occurred after the HSA was opened and funded, your withdrawal may be tax-free even if it’s years or decades later, says financial planner Kelley Long, CPA, finance specialist and consumer financial education advocate for the American Institute. CPAs. You just need to keep receipts for eligible expenses in case you are audited by the IRS.
“I call it the shoebox strategy,” Long says. “You store your receipts because there’s no statute of limitations on when you get reimbursed for qualifying expenses.”
Learn more: Get a health savings account now, you’ll thank yourself in retirement
You’ll want to protect against ink fading so you can read receipts years later, which is why Long recommends making digital copies. She takes a picture of her qualifying receipts and puts them in folders labeled by year.
Superpower 4: You can speed up your children’s retirement
Generally, you cannot claim your children as dependents for tax purposes after age 19 or age 24 if they are students. But many children stay on their parents’ health insurance policies until age 26, giving parents a unique planning opportunity, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.
A child who is not dependent for tax purposes, but still has a parent’s high-deductible health insurance, can create their own individual HSA. Parents can help by giving the child some or all of the money to fund the account.
Related: 3 ways parents can save for their child’s future
The child cannot set up their own HSA if they are still declared as a dependent on the parent’s tax return. And once the child is no longer a dependent, the child’s expenses cannot be used for tax-free withdrawals from the parent’s HSA. But this approach gives the child a tax deduction for the contribution and potentially decades of tax-efficient growth, making it a great strategy for those who can swing it.
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Liz Weston writes for NerdWallet. Email: lweston@nerdwallet.com. Twitter: @lizweston.
