This is the closest thing to a 20-pound box of chocolates from the IRS…

There are very few things in the tax code that are rigged in favor of the taxpayer. The Roth IRA is pretty good…but the one that pulls out all the stops is the Health Savings Account (“HSA”). An HSA is a tax-advantaged account for the payment of qualified medical expenses. It is available to taxpayers who are covered by health insurance that qualifies as a high deductible health plan (“HDHP”)¹. There are several reasons why I think the HSA may be even better than that tax-advantaged darling, the Roth IRA. Read on!

HSA Contributions. Contributions to an HSA are deductible in the year of contribution (take that, Roth IRA – ha!). If contributed directly to an HSA account, they are deducted from your adjusted gross income (“above the line” – the good kind of deduction). If they are contributed through an employee’s payroll deferral, they are pre-tax and exempt from employment taxes (i.e., FICA and Medicare). Additionally, employers are permitted to partially or fully fund their employees’ HSA accounts free of tax to the employee. Maximum contributions are based on the type of coverage an employee has under an HDHP:

Type of HDHP coverage	2023	2024
Employee only	$3,850	$4,150
Family	$7,750	$8,300
Age 55+ catch-up contribution	$1,000	$1,000

This allows a married couple with family HDHP coverage and both spouses age 55 or older to contribute a total of $10,300 ($8,300 + $1,000 + $1,000) to their HSA accounts in 2024.²

HSA Distributions. Distributions from an HSA are tax-free if they are used to pay or reimburse eligible medical expenses³. This can include costs for doctors, dentists, hospitals, lab tests, and prescriptions as well as certain over-the-counter items such as NyQuil, Advil, Bandaids, sunscreen, tampons(!), and condoms(!!). The funds can also be used to reimburse certain Medicare and long-term care insurance premiums. These eligible distributions can be taken at any age and can occur either the year the medical expense is incurred or any year thereafter. For a taxpayer under age 65, any distribution in excess of eligible medical expenses will be subject to tax plus a 10% penalty. Taxpayers 65 or older are permitted to take HSA distributions for any reason without penalty, but the distribution in excess of medical expenses will be taxable.

How is this different from flex-spending? So, this HSA sounds pretty good – deductible contributions, non-taxable distributions – but how is it different than a flex-spending account (“FSA”)? If you have an FSA, you are familiar with the concept of “use it or lose it”. Such is not the case with the HSA. The HSA funds belong to the taxpayer and can be kept in the HSA for years, even after separation from an employer.

So what’s the strategy? The strategy for maximum HSA benefit is to treat it just like you treat your other retirement accounts: invest that money and leave it alone! In the meantime, pay your medical expenses out-of-pocket and (this is key) save your medical expense receipts. Then, years later, once your HSA investments have grown, reimburse yourself for those prior year medical expenses tax-free. This way, you maximize the tax advantage of the income and appreciation of your HSA investments.

HSA Summary and Example. The HSA is a triple tax benefit…

• Contributions are deductible/pre-tax (and not subject to payroll tax)
• Growth and income within the HSA is tax-free⁴
• Distributions (including any appreciation) for medical expenses are tax-free

Trixie Taxie, 51, and her wife Lexie, 56, are covered by a family HDHP plan at Trixie’s work in 2023. Trixie takes full advantage of the available HSA, contributing $7,750 from her paycheck. These funds come out of her check pre-tax and are not subject to FICA/Medicare payroll taxes. Because Lexie is 55 or older, she is eligible to contribute a 2023 catch-up contribution of $1,000 in addition to the $7,750 Trixie has already contributed. Lexie must establish an HSA in her own name and contribute the additional $1,000 by April 15, 2024. Lexie’s contribution will be deducted directly from adjusted gross income on the couple’s 2023 joint income tax return. Both spouses invest the funds as instructed by their personal financial advisors.

In 2023, Trixie and Lexie have their usual medical expenses and also purchase some over-the-counter medicines and supplies. They pay for these expenses out of pocket and save the receipts, leaving their HSA funds to grow in their investments.

Fast-forward to 2040…Trixie and Lexie are both retired and on Medicare. The $8,750 they put into their HSAs and invested wisely in 2023 has now grown to over $20,000. They can use this money (all $20,000 of it) tax-free to reimburse themselves for their Medicare premiums or for any other prior or current year eligible medical expense. Remember those medical expense receipts they saved back in 2023? They can reimburse themselves for those at any time.

It’s just too good to pass up! If you were covered by an HDHP in 2023, you have until April 15, 2024 to fully fund this miraculous account. Don’t miss out!

1. Any taxpayer on Medicare is no longer eligible to contribute to an HSA. ↩︎
2. This would require both spouses to have HSA accounts and at least $1,000 would need to be contributed to each spouse’s account. However, both spouses could be covered by the same HDHP. ↩︎
3. Expenses must be incurred after the HSA is established to be eligible for reimbursement. ↩︎
4. Tax-free if distributed for qualified medical expenses; tax-deferred if distributed for any other reason. ↩︎

^{I provide this for educational and entertainment purposes only. Please consult your own advisors.}