The HSA - Health Savings Account. Another sweet tax deduction
You know we’re all about getting every tax deduction we can here at Freelancer Finance. Sorry, IRS. Less for you, more for us.
The ‘don’t blame me’ blurb: I am not a financial advisor, portfolio manager, or accountant. This is not tax or investment advice; it’s information to get you going. Please consult your trusty professional and do your due diligence. Carry-on!
Opening an HSA (Health Savings Account) means that much of your out-of-pocket medical expenses can become a tax deduction, or you can stash the money in the account for retirement. How are there two ways to use this account? Read on.
In 2024, you can contribute up to $4,150 for singles and $8,300 for families. People over age 55 get an additional $1,000. Go, Gen X and the Boomers!
That means if your net income is $100,000 in 2024 and you contribute $4,000 to the HSA, your taxable income (the income the IRS and states can tax) becomes $96,000.
Read about how you are taxed here. It’s a layer cake of different tax rates. Contributing to the HSA takes money from the top of the cake, your highest tax rate (called your marginal tax rate).
The skinny:
A High-Deductible Health Plan (HDHP) is needed to qualify. In 2024, the deductible must be more than $1,600 or more for singles and $3,200 for families. If your deductible is less, you’re out of luck and cannot have a HSA. Check to see if the plan you choose is HSA-eligible.
Yearly Contribution Limit for the HSA in 2024 is $4,150 for singles and $8,300. Age 55+ get an additional $1,000. To claim the tax deduction, you just have to contribute the money into the account; you don’t have to spend it.
Rolls Over Year to Year: HSA funds roll over year to year; it is not ‘use it or lose it.’ Your HSA stash stays with you, growing over time, unlike its lesser cousin, the FSA (Flexible Spending Account).
Qualified Medical Expenses are the name of the game when spending your HSA funds before age 65. We're talking about out-of-pocket costs, doctor's visit co-pays, prescriptions, dental and vision care, and even over-the-counter meds and medical supplies. The list is pretty broad, but buying a new TV because you're bored in bed recovering from surgery doesn't count. The IRS will mock you as they fine you.
OR — for higher income earners: Don’t use the money for medical expenses; instead, invest it in a Three-Fund Portfolio and let it grow in the tax-protected account. More below.
Insurance Plan Premiums cannot be paid with HSA funds (bummer, I know.)
The Tax Benefits:
1 - Contributions are a tax deduction.
2 - Your gains in the account are not taxable.
3 - You are not taxed when you withdraw the money to pay/reimburse yourself for a qualified medical expense.
4- After age 65, you can spend the funds on anything (like that TV!). Non-qualified expenses will be treated as income, though, and you have to pay income tax on that amount. In that way after age 65 the HSA behaves like a Traditional (deferred) i401k.
5 - No RMD’s. You are not forced to take money out when you hit the Required Minimum Distribution age of 73. (RMDs force you to take money from your deferred retirement accounts (an i401k is one, a Roth i401k is not) at a certain age. It’s Uncle Sam’s way of taxing you before you kick the bucket.
How to set one up and use it:
My usual go-to’s, Schwab and Vanguard, don’t offer an HSA, but Fidelity does, so I went with them. If you open an account with them, I don’t get a referral fee; they just seemed like the best provider.
Apply for and set up an HSA with Fidelity and link your personal bank account, not your business one, as it’s you, not your business, making the contributions. If you don’t have separate accounts for Personal and Biz, get on that ASAP; mixing them is a shit sandwich for your accountant to reconcile. If you ever get audited by the IRS, how will the IRS know what is biz. and what is personal spending and income?
Any money you deposit into the HSA becomes a tax deduction up to the yearly limit. Fidelity send you a 5498-SA for your taxes, showing how much you contributed for the year. They will also send you a 1099-SA showing how much you pulled from your HSA. Give those to your trust accountant.
When you have a qualified expense, you simply transfer the money from the Fidelity HSA to your personal bank account. For example, if you pay a $80 co-pay, you can log on and transfer $80 to your bank account.
Save the receipt for any expense you claim. The IRS can demand to see them. I make a folder on my Mac for every tax year for the HSA, scan the receipts, and dump them in there.
Gains are tax-free or tax deferred. With the Fidelity HSA, your money automatically goes into a Money Market Account. It pays like a high-yield savings account; in April 2024, it paid 5%; remember, gains are tax-free! So that is more like an effective rate of 6.5% if your effective tax rate is around 30%.
It is also a brokerage account, so you can buy stocks and ETFs or Mutual Funds and create a Three-Fund Portfolio, just like we do in our i401k if you build up a large amount of cash. Remember, stocks and ETFs are a long-term buy, though, due to the market going up and down. If you need this money for medical expenses, you don’t want to have to sell your ETFs when they are down during a crash.
The Fidelity HSA dashboard
Transferring money out of the HSA.
From the Fidelity site on what can be claimed. IRS Publication 502 is here, so much fun.
What if I use the money for a non-qualified expense before age 65?
Fines, maybe jail if the IRS audits your HSA spending. (Just kidding about the jail time.)
A 20% fine of the amount used.
You will have to pay income tax on the amount.
The IRS eyeballing you for using your HSA to buy that TV (Pic of the amazing Jaime Lee Curtis playing an IRS agent in Everything Everywhere All at Once)
For higher-income earners — Boost your portfolio
If you are maxing out your pre-tax contributions to the i401k (that’s your personal limit of $23,000 ($30,500 if you are age 50+) and the additional company contribution (20% for non-S-Corps, 25% of your W-2 wages for S-Corps), then the HSA is a great way to sock away more pre-tax money, claim the deduction, and invest for retirement.
After age 65, the HSA behaves exactly the same as a Traditional pre-tax i401k. You can use it for non-medical expenses. Contributions were tax deductions; they grew tax-deferred and now can be spent on anything, but the withdrawal is taxable, the same as the traditional i401k. Of course, you can still use it for qualified medical expenses, which would be tax-free.
Invest it.
Example: Let’s say you contribute $4,000 from age 40 to 65 ($333/month), which grows at 7% using a Three-Fund Portfolio. At age 65, the balance will be around $274,000. Boom.
The Bottom Line
HSAs are a fantastic way to claim the tax deduction and save for medical expenses or invest long-term. They offer flexibility, tax advantages, and the potential for growth through investments.
Comments, questions? Hit me up below.