President Trump has suggested health savings accounts as an alternative to Obamacare for Americans to handle their healthcare costs. Let’s take a look at what HSAs are, how they work, and if an HSA is right for you.
What is a health savings account?
A health savings account, or HSA, is a special savings and investment account designed to be used exclusively for healthcare related spending. Like a 401(k) or IRA, it has unique tax rules that can save you a ton of money compared to just paying for healthcare costs out of pocket from a regular bank account or credit card.
To qualify for an HSA, you must have a qualifying high deductible health plan, or HDHP, for your health insurance. IRS rules define HDHP insurance plans as any insurance policy with a deductible of $1,300 or higher for individuals or $2,600 for families.
How do health savings account taxes work?
In a regular investment or bank account, you pay taxes on your income and on any capital gains. With an HSA, you don’t pay any income taxes on cash you deposit and don’t have to pay any capital gains or other taxes when you withdraw. That is a better deal than you can get from a 401(k) or IRA!
The current limit you can save in an HSA is $3,400 for single individuals and $6,750 for families. If you contribute the entire $6,750 for a family and your top tax bracket is 28%, you would save $1,890 on your current year taxes. That is a huge savings!
When you contribute to an HSA, most account providers allow you to choose between keeping your funds in a regular savings account with minimal interest or investing in riskier investments for better returns. I have the bulk of my HSA balance in low-fee index funds like an S&P 500 index fund.
When you withdraw funds for any qualified medical expense, you do not pay any taxes on the withdrawal. Whether your cash just sat there earning bank interest or earned thousands from investments, withdrawals for medical purposes are tax free. If you withdraw for any other reason, the withdrawal requires paying taxes and penalties.