This year, we have rolled out our financial education series.   The goal of the series is to educate investors and individuals seeking to improve their finances, whether they are just starting out on their journey or are far along.   We’ve covered topics such as “What Is A Dividend?” and “Who and What Is Vanguard?” and “What is the S&P 500?” Now, we wanted to cover a topic that can save individuals on their annual taxes, provide a savings account for health expenses, and the kicker, even provide investors with some additional dividend income.   Sounds great, right?   There are some catches.  So let’s dive in an learn what a Health Savings Account is and some of the benefits that come along with it.

What is a health savings account (HSA)?

Health Savings Accounts (HSA) are a relatively new concept.   HSAs were created in 2003 (officially became law in 2004) as a part of the Medicare Prescription Drug, Improvement, and Modernization Act.  A Health Savings Account is a tax-advantaged savings account available to individuals that participate in a high-deductible health insurance plan.   The key here is that your current health insurance plan must be a high-deductible healthcare plan.  If not, unfortunately, you cannot contribute to a HSA account.

A HSA can be used to cover qualified  healthcare expenditures.  The list is defined by the IRS and as you can imagine, the list is rather long.  I’ll summarize a few of the expenses, but here is the link to the full IRS code for reference if you would like to look up a specific expenditure.   I don’t want to leave you with just a link to a website, so here are some of the typical expenses I associate as covered with my HSA:  co-pays for doctor care, lab fees, prescriptions, dental treatments, vision expenses, insulin, etc.  Of course the list goes on for a while, so make sure you review the complete listing of qualified medical expenses before paying a large medical bill.

Unlike a FSA account, if you do not use the amount contributed during the year, the balance rolls over to the next year.   There is no “use it or lose it” provision for a HSA account!   One cool feature is that an HSA can also function as a retirement account as well.  Beginning at the age of 65, an individual can begin withdrawing funds from a HSA account for all expenses, not just medical expenses, without penalty.

Health SAvings account (HSA) – How to Contribute?

Now that you know that you are a part of a high-deductible health plan and you know you are eligible to contribute to a HSA account, how do you go about doing it?  First, start with your employer.   Most employers, at least the large organizations, offer a Health Savings Account  option.  You can sign-up with their HSA provider and begin making contributions each paycheck.  There are some nice tax benefits to this option, discussed in the following section.

If you employer does not offer a HSA, the good news is that you can still contribute.  Institutions such as Vanguard, Fidelity, TD Ameritrade, Lively (Learn more about Lively here), HSA Bank, and others offer individuals with a high-deductible health plan the opportunity to open an HSA account.  My HSA is through my employer, so I have not had to put too much consideration into this option before.  But it is nice knowing that it is out there if ever needed.

Whether or not you open a HSA through your employer or through another option, always ensure that the HSA account is FDIC insured and that you have reviewed the account’s fees.  Unfortunately, most HSA services charge a fee.  So please make sure you have considered this in your analysis.

HEalth Savings Account – Annual Contribution Limits

Of course there are.  Unfortunately, you cannot contribute unlimited amounts of capital to these accounts.  How nice would that be?  In 2018, the IRS HSA contribution limits were $3,450 for an individual and $6,900 for a family (if both individuals participate in a high-deductible health plan).  In 2019, the limits increased slightly.  Individuals can contribute up to $3,500 and families can contribute up to $7,000.

The government does allow a “catch-up” option for individuals that are 55 and older.  If you are above 55, you are eligible to contribute an additional $1,000 per year.

health savings account (HSA) Tax Benefits – Explained

Lanny covered this topic several years ago, but I wanted to revisit the tax-benefits of a HSA.   For this example, I will start by explaining the benefits of an HSA plan that is offered through your employer where and individual is contributing each pay-check.

HSA contributions through your employer are made on a pre-tax basis.  Thus, you will not pay federal, state, or local taxes (please confirm this with your jurisdiction) on the pre-tax contributions.  For me personally, the savings are huge.  We will most likely be in the 22% federal tax bracket and 4.6% for the state of Ohio.  My local taxes are about 2%.   Now, I understand that the federal and state tax brackets pay on a graduating scale, so the percentages above are not the full tax expense incurred.  But it does help illustrate the amount of taxes saved for each pre-tax dollar contributed to your HSA.   If you live in a state with higher taxes, such as California or New York, imagine how much you could save on your taxes.  These tax benefits will be received whether you contribute through your employer or through a place like Vanguard.

But wait, there is one more!! If you contribute via pay-check on a pre-tax basis.  Your taxable income subject to the Social Security Tax  (6.2%) and Medicare Tax (1.45%) will decrease by the amount contributed.   Since contributions to non-employer plans are made on an after-tax basis, you will not receive this benefit. Look at that right there!

How Can I Earn Dividend Income with my health savings account (HSA)?

Come on, we are the Dividend Diplomats.  You know there had to be an investing and dividend income twist to this article, right?   The two of us actually earn dividend income on our HSA balances each quarter.  That’s right, dividend income!  Here is how.

Some plans offer an investment option when the cash balance exceeds a certain dollar threshold.    For example, our old plan allowed us to invest every dollar in pre-selected mutual funds once there was a $1,000 cash balance in our HSA account.  Not every employer’s HSA plan offers this though. Please make sure you review your plan before assuming this is a possibility.  And another thing to keep your eye on with an investment options are the monthly fees.  Some plans may charge a dollar amount per month to allow you to invest, which would potentially eat into your return. 

So assuming you have no medical expenses in 2018 and you contributed the maximum $3,450 allowed.  Your HSA cash balance would be $1,000 and you could invest $2,450 in a mutual fund.  If the mutual fund has a dividend yield of 2%, the investment would produce $49 in dividend income annually.  How cool is that?  Think about how additional HSA contributions, dividend increases, and the power of dividend re-investment would continue to grow your dividend income.

Other Questions about a Health savings account (HSA)

I’ve already gone through a lot of information about a health savings account above and explained some of the tax benefits associated with the account.   However, I thought it would be a good idea to perform a quick rapid fire section to address a few burning questions.

What Happens to Your HSA Account if You Leave Your Employer? 

The HSA account is YOUR account, not your employers.  There are several options for you once you change jobs.  First, you can do nothing!  You can maintain HSA accounts at several locations if you desire.  But as always, watch out for additional fees that may be applied once you are not regularly contributing to your HSA account.

If you would like to have all of your HSA funds in one place rather than multiple locations, the IRS allows one rollover every 12 months.  Performing multiple rollovers in a 12-month time-frame may jeopardize the tax-benefit status of the account

What if My Employer Contributes a specified dollar amount annually to my HSA account?

Unlike a 401k match, any amount contributed by your employer counts against your annual contribution limit.  If your employer contributes $100 in 2018, you will only be able to contribute $3,350 (individual account) or $6,800 (family).  IF your employer contributes $500, you can only contribute $2,950/$6,400, respectively.

Summary

Hopefully you have found this article informative and helpful.  A Health Savings Account (HSA) is a great option to allow you to save for medical expenses and retirement while reducing your current tax expense.   If you have a high-deductible health plan, I would strongly suggest looking into this and performing additional research to see if this is the right fit for you and your family!

Do you have a HSA account?  Are there any additional tidbits you have learned about HSA accounts that were not covered in this article?  If so, please share these findings in the comment section so we can all learn a little more!

-The Dividend Diplomats