My HSA will pay for what?!

Health Savings Accounts (HSAs) are skyrocketing in popularity as premium increases have become the new normal in this uncertain market. In fact, recent reports project 30 million accounts, with assets exceeding $60 billion, by the end of 2019. To put those numbers into perspective, there were around 6 million accounts in 2008.

HSAs also remain popular because consumers are looking for more choices and more ways to save. For example, HSAs offer triple tax savings. This means any HSA contributions can be made either pre-tax or are tax deductible at year-end. Any interest income or earnings on investments tied to an HSA remains tax free.

Additional HSA benefits include

100% of unused funds roll over year-after-year
Funds go with you even if you switch employers
Can pay for the eligible expenses of your legal spouse and tax dependents regardless of their insurance
Can be used for Medicare premiums as well as qualified long-term care premiums
Further, there are literally hundreds of ways to spend HSA funds. In fact, the IRS has laid out an extensive list of allowable expenditures in IRS Publication 502. Many probably take it for granted that HSA funds will cover a doctor’s visit; however, most are probably unaware that the IRS considers these services as allowable expenses:

Travel expenses and lodging
It’s an eligible expense if the costs associated with transportation and lodging essential to and primarily for medical care.
Note: Lodging expenses are limited to $50 per person up to a maximum of $100 per night. Additional requirements for lodging include:
Medical care must be provide by a doctor in a licensed healthcare facility
Lodging is not lavish or extravagant
There is no significant element of personal leisure in the travel
Eye surgery
The cost associated with laser or LASIK eye surgery is an eligible expense.
Artificial eye, limb and teeth
Amount paid for the design and purchase of an artificial limb, eye or teeth is an eligible medical expense.
Birth control pills
The cost of prescription birth control (such as IUD, diaphragm, pill, Norplant, etc.) is an eligible medical expense. In addition, amounts paid for OTC products and devices (such as condoms, etc.) are eligible medical expenses.
Chiropractic and acupuncture treatments
Massage therapy may qualify for HSA compensation in certain situations, as well!
Drug and alcohol addiction treatment
The cost of treatment at a center for alcohol or drug addiction is an eligible medical expense. This includes meals and lodging provided by an inpatient center during treatment
Artificial Reproductive Technologies
A health care professional must provide evidence of medical necessity for the cost of Artificial Reproductive procedures to be an eligible medical expense. Evidence of medical necessity must be included by providing a Letter of Medical Necessity (LMN) that specifically identifies the recommendation and expense is for treatment of a medical condition with the request for reimbursement.
To qualify as potentially eligible, procedures must be intended to overcome an inability to have children due to medical reasons and are performed on you, your spouse or your dependent.
Home improvements such as ramps or doorways to accommodate a wheelchair
A health care professional must provide evidence of medical necessity for the cost of installing equipment in the home to be an eligible medical expense. Evidence of medical necessity must be included by providing a Letter of Medical Necessity (LMN) that specifically identifies the recommendation and expense is for treatment of a medical condition with the request for reimbursement.
Smoking cessation programs
The cost of participating in a smoking cessation program is an eligible expense.
Tutoring or tuition costs for children with medical-related learning disabilities
A health care professional must provide evidence of medical necessity for the cost of tuition/tutoring fees covering services rendered specifically for your child’s severe learning disabilities caused by mental or physical impairments to be an eligible medical expense. Evidence of medical necessity must be included by providing a Letter of Medical Necessity (LMN) that specifically identifies the recommendation and that the expense is for treatment of a medical condition with the request for reimbursement.

Conventional wisdom suggests that employees owning an HSA and retirement account, such as a 401(k) or IRA, should first contribute to their retirement accounts, and then max out their HSA contributions through payroll deductions. While this is an attractive strategy, an even better one is for employees to first max out HSA contributions regardless of their tax bracket, and contribute to their traditional retirement plans afterwards.

Why contribute to an HSA first

While a 401(k) plan will beat an HSA if left to retirement, reality hits when withdrawals are made from the 401(k) to pay for things like medical expenses – not to mention a 401(k), and other traditional retirement plans, are burdened with taxes and penalties. With health care being one of the biggest expenses most individuals will face during retirement, an “HSA first” approach makes the most sense, as it offers a unique triple-tax advantage.

Additional HSA benefits

For those who are uncomfortable with this strategy, there are several additional benefits to an HSA, such as

100% of unused funds roll over year-after-year
Funds go with you even if you switch employers
Can pay for the eligible expenses of your legal spouse and tax dependents regardless of their insurance
Can be used for Medicare premiums as well as qualified long-term care premiums
An individual can also reimburse for out-of-pocket health expenses at any time – even 30 or 40 years in the future. During that time, money grows in the HSA tax free. Some refer to the HSA as a “stealth IRA” when it’s used this way.

There’s no downside to maxing out your HSA contribution

Having tax-free funds available to pay medical costs, as opposed to utilizing the taxable 401(k) or IRA distribution, can make a huge difference to retirees. For those lucky few with little need for health care spending or savings during retirement, HSA funds are accessible for distribution for any purpose, without penalty, once the account holder reaches age 65. Non-qualified withdrawals are taxable, but so are withdrawals from pre-tax retirement accounts.

Many are unaware of this fact, but HSAs can also be invested into bank accounts, stocks, bonds, money market funds and mutual funds. Rather than using the HSA solely to pay for medical expenses, participants have the flexibility to invest and choose when and when not to use their HSA dollars. And while it’s not possible to move HSA funds into an IRA or 401(k), participants may roll IRA funds directly into an HSA, and there’s an indirect way to move 401(k) funds from a former employer into an HSA. Participants may do this once in a lifetime.

So what’s the catch? There has to be a downside, right? Ultimately, there is no downside to the “HSA first” approach to maxing out contributions. However, before switching investment strategies, participants should look to their financial advisors for guidance.