The Ultimate Guide to Health Savings Accounts: Part 3

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Money saved can be money earned.

In two previous articles I explained the basics and features of health savings accounts (HSAs). Let’s wrap up by discussing some advanced strategies:


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  1. Lower insurance premiums and invest the difference

Remember that you are eligible to contribute to the HSA if you have a high deductible health insurance plan (HDHP plan). The higher deductible means that you’ll pay a lower premium versus a traditional health insurance plan. Hypothetically let’s say you’re 40-years-old, married with two kids, everyone’s healthy and your monthly premium for a traditional family health insurance plan last year was $1,000. Now let’s say on Jan 1st of this year you switched to a HDHP plan that has a monthly premium of $600. You max out your $7,000 pretax contribution to the HSA account – good job!

But wait! Did you realize you also now have almost $7,000 a year in extra cash flow by lowering your health insurance premium and lowering your tax burden? Take that extra cash flow to max out other retirement plans such your SEP IRA or employer sponsored 401k, or if you’ve already done that, then invest the difference in a good old fashioned taxable (brokerage) account.

  1. Make contributions via payroll deductions and save on FICA taxes

As I discussed before you have two options for HSA contributions: (1) payroll deductions via your paycheck into an HSA account your employer has set up for you or (2) contributions from your checking account to an HSA account you’ve set up yourself. According to the IRS “HSA contributions made under a salary reduction arrangement in a section 125 cafeteria plan aren’t wages and aren’t subject to employment taxes or withholding.” What this means is that if you contribute to the HSA via payroll deductions, you don’t have to pay Social Security or Medicare taxes on those contributions. However if you contribute via your personal checking account, then you will be subject to those taxes. Most physicians will already reach the Social Security wage base cap so really you’ll be saving on some Medicare taxes. Assuming you contribute the $7,000 max (age less than 55) then that would save you somewhere between $100-$200 in FICA taxes. Remember you still lower your income tax bill as well.


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  1. Do partial transfers to a second HSA account

I’ve seen a number of employer-provided HSA accounts, which have high fees, limited investment options or mutual funds with high expense ratios. If you’re stuck with investment options you don’t like, you can open a second HSA account with a different HSA custodian and then transfer your employer provided HSA to the second HSA. The process goes like this:

  • Get the employer HSA contribution (free money) and the lower FICA tax bill by continuing payroll deductions to the employer provided HSA
  • Periodically – say once a year or every two years – transfer the balance from the employer provided HSA to the better HSA custodian

Note that there may be a transfer fee involved every time.

  1. Save receipts and pay later

Let’s say you are disciplined and max out your HSA contributions annually to get the tax benefit and invest the money to use at a later date for medical expenses. Along the way you incur some medical expenses and decide to pay those expenses out of pocket rather than taking withdrawals from the HSA. If you save your medical expense receipts (this is key), you can withdraw money from the HSA tax free in a later year to reimburse yourself for medical expenses you incurred in a previous year. Let’s say this year you pay $1,000 out of pocket for medical expenses. As long as you keep records, you can take a $1,000 withdrawal from the HSA in 2025 to reimburse yourself for the $1,000 medical expenses you incurred in 2019. Why would you do this? It’s to take advantage of compound growth on the HSA contributions.

  1. Use as IRA at age 65

Remember that when you withdraw money from the HSA, it’s income tax free as long you use it for qualified medical expenses. But what if you use it for non-medical expenses? You’ll pay taxes and an additional penalty. That changes a little after age 65. At that age if you don’t use the HSA for medical expenses, it effectively becomes a traditional IRA in the sense that you can withdraw money and pay tax, but you won’t pay any penalties. This could be useful in the situation where you withdraw more money in a particular year than the total medical expenses you incurred.


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  1. Add limited purpose FSA

Recall from a previous discussion that you cannot have both a FSA (flexible spending account) and HSA at the same time. In the FSA, you make pretax contributions to use for medical expenses, but you must use those contributions in the same year or you lose the remaining balance at the end of the year. If you have an HSA, while you cannot contribute to a FSA, you can contribute to a limited purpose FSA (LPFSA) at the same time. The LPFSA allows you to make pretax contributions to pay for vision and dental expenses for the year. Assuming you have a family HDHP plan and make $7,000 pretax contributions to the HSA, you can also make $2,700 pretax contribution to the LPFSA for total of $9,700 in pretax contributions across the two. The combined tax benefit would be over $3,800 assuming 40% marginal tax bracket (federal and state).

 

ABOUT THE AUTHOR

Setu Mazumdar, MD, CFP® is board certified in EM and is the president of Physician Wealth Solutions Inc., a wealth management firm helping physicians with financial planning and investment management.

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