What is an HSA and how does it work?

HSAs and the triple-tax advantage. It's the only thing like this. Health savings accounts. It's designed for now and the future. I think you'd be hard pressed to find a bigger HSA cheerleader than you. That's true. Love the HSA. Today, we're talking HSAs. With health care costs on the rise, health savings accounts can be a powerful tool to help you save for medical expenses both now and in retirement. Hi, I'm Ally Donnelly, and this is Money Unscripted, a podcast from Fidelity. We're talking life and money, jargon and judgment-free. So HSAs. How do they work? How much can you save? And what is that triple-tax advantage everyone keeps talking about? To walk us through the benefits and questions around these accounts, Amy Richardson is here. She's a Fidelity Vice President in Health and Benefit Accounts. Amy, thanks for joining us. Thank you so much for having me. So you know, there's a lot of jargon and acronyms when we talk about HSAs, and it can be like a little off-putting or maybe a little overwhelming. So first and foremost, just break it down. What is an HSA? An HSA is a health savings account, which is something that you can use if you're enrolled in a high-deductible health plan. And it is a tax-advantaged way to save money for health expenses both now and in retirement. All right. Tax advantaged. I mean, I don't know anybody who wants to pay more taxes than they are required to. But what does that mean, tax advantage, tax efficient? What is that? This is the most amazing thing about an HSA, is that it's the only investment vehicle where you can get triple tax advantages. So you put money into your HSA before taxes, like a 401(k). And then the money will grow, tax-deferred. And as long as you use it for qualified medical expenses, you don't pay any taxes on it when you take the money out. Flexible spending accounts, FSAs versus HSAs. What's the difference between an FSA flexible spending account and an HSA? Yes. And it does get confusing, right? It's a lot of alphabet soup. Sounds about the same. An FSA is a flexible spending account, which means that you need to spend it by the end of that year in which you've contributed to it. An HSA is a health savings account. So it's designed to be saving beyond the year in which you're putting it in. So you can spend it, but then you can also save in that account. It's yours. It carries over from year to year. It's your account to take with you if you leave your employer, whereas your FSA is tied to that employer and that plan year. All right. So FSA, use it or lose it. Use it or lose it. OK. So you mentioned that you have to have a high-deductible health plan to be eligible for an HSA. How do I know that my health plan is the right kind? One way to be sure is to check with your insurance company. They can confirm that. You can also check with your employer. And when annual enrollment comes around, if you are not currently in a high-deductible health plan, that's usually when you can make your elections for what health plan you want to change to for the next year. The high deductible makes you eligible to open up an HSA. And one of the things to consider at that point in time is what you're paying now when you factor in your premiums plus your co-pays. And when you enroll in your high-deductible health plan, you'll pay lower premiums in exchange for the high deductible, but you can put that money, tax advantaged, into an HSA to cover that deductible and more. Yeah, open enrollment. I feel like so many people I talk to, like they're just overwhelmed by choices and make that decision quickly. You told me a great story or a great analogy. So if you were going to purchase a car, you spend about nine hours over 89 days researching that car decision. When someone elects their health benefits, they spend about eight minutes, which is about the amount of time it takes to say, the same as last year. This is really your time to be looking at the overall math, the cost, the whole pieces of it, and see how it fits together, because you could be leaving some opportunity on the table. And that's it, right? I mean, it's pretty stunning to think about spending that much time on a car and next to nothing on something that could have a huge impact. And you're going to spend the same amount every month probably on both of them either way. We talked about investing. So is the money I have in my HSA automatically invested? Do I have to do something. It is not automatically invested, mainly because you'll want to choose your own investments depending on a number of different factors. But also, you may need to be spending some of the money in there. So you might not want to invest at all. So it's going to come in to a core position, and then you can set up automatic investments so that it will go in to the automatic investments every time it arrives in the account. The other thing too is that you can set a cash target, so that you always have enough to cover maybe an emergency room visit or maybe your deductible, the full deductible amount, and then invest on top of that if it's something that you might not want to pay out of pocket and you want to use your HSA to spend. What do you mean cash target? So I could say that I want to make sure I always have $500 available because the last time I left an emergency room, they said I had to pay $475. So I could leave that amount in there. Or I could say, well, my deductible for my family is, say, $3,000. I want $3,000 in cash, so I know that I have that for the deductible this year. But everything I contribute on top of that, I want it invested. So what difference have you seen for people who invest their HSA money and people who don't? Yes. So because you get to benefit from the compounded growth, we tend to see account balances seven times higher for those who are investing in their HSA. Wow. OK. That's no small thing. No, not at all. I still feel like even though HSAs have been around, right? I still feel like a lot of people I talk to don't know so much about it, or they don't have one, or they don't know if they have one. So can I only get an HSA through my employer? No. No. You do not have to get your HSA through your employer. You can actually open up an HSA at Fidelity, at another financial institution, at your local bank. Your employer may have an affiliation with a financial company, and you would want to look into that because they may also contribute some money to your HSA. But you can hold an HSA in multiple places as long as you don't over contribute to it based on the maximums for that year. So if my limit is x, I can't put more than that in these multiple accounts. Correct. And what about the tie to the health plan? Does it still have to be high deductible? You always have to have a high-deductible health plan to open up an HSA. If you no longer had a high-deductible health plan, the HSA can remain open. You just cannot contribute to it while you're not enrolled in a high-deductible health plan. OK. So let's say I get my HSA through my employer, right? And then I get laid off, or I take a new job, and that doesn't offer an HSA. What do I do? So that HSA is yours to keep. OK. And so you can leave it through the financial institution that you opened it with your employer. You can also transfer it or roll it over to another HSA at a different financial institution. There's no tax consequences for that. You can also spend it down on qualified medical expenses or invest it all for the future. OK. And if my new employer doesn't have the high-deductible plan, do I lose the money there? No. It's still yours to keep. It's your account. It follows you wherever. It does. Let's talk turkey. How much can you contribute to an HSA every year? Someone enrolled in individual coverage in a high-deductible health plan can contribute $4,150. And family coverage in a high-deductible health plan is $8,300 for this year. OK. So for 2024. What about folks who are a little older? There are catch-up contributions available. It's $1,000 if you're over age 55. And if it's a family plan, that is $1,000 for the employee and also their spouse. OK. So that's how much I can save, right? Is there a number that I should be targeting, so to speak? I know everyone's situation is different. It is. I mean, the answer to that always is that it depends. And really, you should be thinking about your HSA as part of your overall investment strategy. We kind of like to think of it as a retirement plan twin, that it's something you're already saving for retirement, but really saving for medical expenses in retirement is important as well. So I would say as much as you can save is what you'd want to save. But really, you're getting the tax advantage by doing anything with your HSA. So if you put the money in on a pre-tax basis and you spend it that year, you're going to spend it anyway. So you might as well get the tax advantage by putting it in the HSA. If you end up not spending it all, it's going to carry over to the next year, and you can invest that amount that you carried over to the next year as you contribute the amount that you think you need for this year. We do have a calculator on Fidelity.com that would let you look through some of these things. I also encourage you to think about the premiums and the difference in premiums that you'd be paying on a high-deductible health plan, which is going to have a lower premium most of the time than another type of health plan. And if you put the difference into your HSA, then you'd also have a way to save that way. So you just mentioned health care costs in retirement. And I feel like the older I get, the more I'm like getting to know the numbers. So how can-- talk to me about those numbers, and then how can an HSA help? Right now, Americans think that a married couple will spend $41,000 on medical expenses in retirement. In actuality, an individual can expect to spend $157,500 in retirement on medical expenses and a married couple, $315,000. So yes, we do want to say yes. We want to save early. We want to save often. And so the way that an HSA can help is that you're putting this money aside in a taxadvantaged way that growth is going to be compounded. You're saving in it the same way that you would be saving in a retirement plan, except this is for medical expenses. And if you need it for medical expenses along the way, you have access to it. When you turn 65, it basically converts to a type of IRA or 401(k) if you don't need to spend it on medical expenses. Now I just told you how much you're probably going to need on medical expenses. So chances are you'll need it for medical expenses. But if you don't, then it just works like a retirement plan, meaning that you would pay ordinary income tax on what you take out of that account. So if I use it for something non-medical related, no problem if I'm 65 plus, but I'll pay tax. Correct. OK. Hit me with that early again because I feel like there's so many woulda, coulda, shouldas that as you age, you see. Talk to my 30-year-old self, will ya? Well, remember when he first started working, people talked about a 401(k), and you could not even think about saving for retirement. But someone said you have to do it. And so you started doing it, and you saw it grow. It's the same thing with the HSA, is once you start putting it in there, you're going to not miss it from your paycheck anymore. You get used to that. And then if you invest it, you can have that compounded growth. Start early. Save it up in there. Spend what you need to. And that's the other great thing about it, is you can access it. So you wouldn't have to take a hardship for medical expenses from your 401(k) where you'd have to pay taxes and a penalty. You could use your HSA money to cover anything that you'd need for medical expenses and then continue saving the rest. I was really surprised to hear some of the things you could use an HSA for. You know, I think FSA, I think my contact solution, and glasses, and dentists, and stuff like that. But there's more and interesting things you can pay for with an HSA. Absolutely, yeah. Some things that you may not think about are if you needed to make modifications to your home for say a ramp for a wheelchair or travel expenses to go stay if you need to get care out of town somewhere. So a number of different things. Even if you have a child with special education needs, a tutor to learn Braille, for example, can be covered with an HSA. So a number of different things, plus the other qualified medical expenses that you might expect. That's great. Yeah. And so long as you're using them on those qualified medical expenses, you're not paying for taxes. Correct. The other thing too is that you can reimburse yourself from your HSA back in time for any expenses that you spent on medical since you opened the HSA. So for example, if I pay out of pocket for my prescriptions right now, I might want to save my receipts, so that in the future, I can reimburse myself for that money. This is so funny. We just had this conversation yesterday with our videographer, Jim. And he was saying that his wife went back two years and got receipts. But there are some parameters around that, right? Correct. It has to be after you enrolled in the high-deductible health plan and after you open the HSA. So you're reimbursing yourself for things that you could have used your HSA for at that point in time but you chose not to because you left it in the plan. You could reimburse yourself back to that point in time. OK. So long as you had the HSA account established when you spent that money. So what happens if there's money left in this account and I pass away? That's actually also an it depends question. So you can and absolutely should set up a beneficiary on your HSA and on all accounts that you have make it easier for people later on. But if you are leaving your HSA to a spouse, then the spouse will receive the HSA in the same form as an HSA. They'd be able to use it the same way. OK. If you're leaving it to a non-spouse, then it is taxable to that person, but they can receive the funds that are in the HSA. And if you don't name a beneficiary, then it becomes part of your final tax return. You know, we talked about the investment opportunity, right? The money compounding. But as I'm thinking about my HSA, should I be spending some money out of that every year, or should I just try and save it for later at all costs? Not all costs, but you know what I mean. Yeah. No. I do know what you mean. And the answer to that is it depends. And really, it's probably a combination of things because there are things you may need to spend it on to, to cover things right now. And then if you can save it and you don't have as many medical expenses in a year, then you could save and invest that amount. Most people do use it like a spectrum. You usually have a debit card that you can use for spending for right now, and then you have all these opportunities to save. What I would say is you can think creatively with the HSA too. So say if someone said, I just don't have it in my budget right now to save for my HSA, when you receive a medical bill for a high-deductible health plan expense, you could put the money in the HSA and then pay your bill from the HSA. So at least you get one out of the three tax advantages there. So you can use this account to your advantage for whatever you need to use it for. Do I need an advisor to set up an HSA for me? I think an advisor would certainly be able to assist in looking at your entire financial profile and where the HSA would fit into that. That may even help with how you invest in the HSA versus how you invest in a different type of an account in case you do plan to spend some of it now versus save it all for the future. But you can open up an HSA on your own as well, And then there are usually tools to help you decide how you invest it, how much to leave in cash, the calculator we talked about earlier, plus investing tools and managed accounts too where the investments are chosen for you. OK. All right. So I've listened to this. I've watched this. I'm in. I want to open an HSA. What do I do? Super easy to do. So very first thing, just as a reminder, you do have to be enrolled in an HSA eligible plan, which is a high-deductible health plan. Once you do that, you can go check with your employer if they have one established. So you can open up through your employer with the relationship that they may have with a financial institution. Or you can go to any financial institution and open up an HSA. It's as simple as just opening up an account. And then you can start contributing to it right away. I think you'd be hard pressed to find a bigger HSA cheerleader than you. That's true. It is the only triple tax-advantaged vehicle. Hit me one more time with the triple-tax advantage. So you put money in on a pre-tax basis. So you're not paying taxes on the money that you put into the HSA. Anything you spend it on, as long as it's a qualified medical expense, you do not pay taxes on. And you can invest it for future growth, and all of that growth is not going to be taxed as well. And you don't lose it. It is yours to keep No use it or lose it like an FSA. It's designed to be for now in the future. Awesome. Amy, this is great. Thank you so much. Yeah, my pleasure. I love talking about HSAs. Thanks to Amy, and thanks to all of you for being here. If you're looking for more information on HSAs, including that calculator tool that we talked about, head to our website. It's Fidelity.com/MoneyUnscripted. Be sure to like, follow, subscribe, share the podcast, and we'll see you next time here on Money Unscripted. It's your life. Get your money's worth. Footnotes and disclosures: Autolist, “How long does it take to buy a car,” 2021 2023 Midyear Devenir HSA Research Report Fidelity does not determine what is a qualified medical expense. We recommend consulting the IRS's guide in Publication 502 to see what's qualified and what isn't. If your employer allows you to make pre-tax payroll contributions to an HSA, those are both FICA tax-free and federal income tax-free. Please check with your employer to see if this is possible with an HSA outside of one they provide. Although post-tax contributions are federal income tax-deductible, you will be required to pay FICA taxes on those contributions. This means post-tax HSA contributions may not be as tax-advantaged as pre-tax HSA contributions. Triple Tax Benefit: With respect to federal taxation only. Contributions, investment earnings, and distributions may or may not be subject to state taxation. The Health Savings Calculator and related tools are provided by DST Systems, Inc., an SS&C company, a party unaffiliated with National Financial Services LLC, or Fidelity Brokerage Services LLC (“Fidelity”), or your firm. Except for Fidelity providing the Retiree healthcare numbers to be used in the calculator, neither Fidelity nor your firm has been involved in the preparation or the content supplied by SS&C and does not guarantee or assume any responsibility for its content. The information contained herein is general in nature, is provided for informational and educational purposes only, and should not be considered legal or tax advice. The information is not tailored to the investment needs of any specific investor. Fidelity Investments 22nd annual Retiree Health Care Cost Estimate: Estimate based on a single person retiring in 2023, 65-years-old, with life expectancies that align with Society of Actuaries' RP-2014 Healthy Annuitant rates projected with Mortality Improvements Scale MP2020 as of 2022. Actual assets needed may be more or less depending on actual health status, area of residence, and longevity. Estimate is net of taxes. The Fidelity Retiree Health Care Cost Estimate assumes individuals do not have employer-provided retiree health care coverage, but do qualify for the federal government’s insurance program, original Medicare. The calculation takes into account Medicare Part B base premiums and cost-sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B (inpatient and outpatient medical insurance). It also considers Medicare Part D (prescription drug coverage) premiums and out-of-pocket costs, as well as certain services excluded by original Medicare. The estimate does not include other health-related expenses, such as over-the-counter medications, most dental services and long-term care. Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation. The information provided herein is general in nature. It is not intended, nor should it be construed, as legal or tax advice. Because the administration of an HSA is a taxpayer responsibility, you are strongly encouraged to consult your tax advisor before opening an HSA. You are also encouraged to review information available from the Internal Revenue Service (IRS) for taxpayers, which can be found on the IRS website at IRS.gov. You can find IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and IRS Publication 502, Medical and Dental Expenses, online, or you can call the IRS to request a copy of each at 800-829-3676. Investing involves risk, including risk of loss. Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. 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