About the author: Lamar Watson, CFP®, is a Fee-Only Financial Advisor in the Washington, D.C. area, that works with clients virtually across the country. Lamar's work with his clients focuses on budgeting, employee benefits, paying down debt, buying their first home, and investing. Lamar is the Founder of Dream Financial Planning, a virtual financial planning firm specifically designed to help young professionals and minorities take control of their finances and fulfill their dreams. Feel free to schedule a complimentary consultation to learn how we use the The DREAM Financial Planning Process ™ to help our clients achieve their goals.
The average annual healthcare expense per individual rises from roughly $2,000 for 19-year-olds to about $11,000 for retirees (age 65+).1 As Americans pay more for medical care, they often seek ways to save for emergencies. Health savings accounts (HSAs) and health reimbursement accounts (HRAs) can help.
What are these accounts and who has access to them? We explore the pros and cons of each option to help you determine which you may have access too and the best one for your individual needs. Feel free to check out the PDF guide below for helpful tips.
What Is a Health Savings Account?
An HSA can be used to save for future medical costs. They tend to have multiple tax benefits including:
- Pre-tax income is deducted from your paycheck, lowering your total taxable income.
- Your HSA balance grows tax-free.
- The IRS won't tax money you withdraw to pay for medical expenses.2
How Do I Qualify for an HSA?
To be eligible for an HSA, you must be enrolled in a High Deductible Health Plan (HDHP). Not only do these plans offer a tremendous tax benefit, they serve as another avenue for retirement savings. These accounts offer a win-win situation by balancing today’s savings and planning for the future. In exchange for lower premiums, an HDHP has higher deductibles. If you have large unforeseen medical expenses, you may have sizeable out-of-pocket expenses. In addition, you can not:
- Be claimed as a dependent on the previous year’s tax return.
- Have Medicare.
- Have any other health coverage, aside from certain exceptions as outlined by the IRS.2
What qualifies for a high deductible health plan?
For 2020, the IRS defines a high deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. An HDHP'S total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) can't be more than $6,900 for an individual or $13,800 for a family
The tax advantages of an HSA are as follows:
- Contributions to an HSA are pre-tax or tax-deductible. Just like a 401(k), 403(b) or IRA.
- Earnings grow tax-deferred. Just like a 401(k), 403(b), or IRA.
- Withdrawals for eligible medical expenses are tax-free.
In order to qualify for an HSA, you must have an HDHP (high deductible health plan). This doesn't work for everyone, particularly those with high healthcare costs.
When using HSA funds for non-qualified medical expenses before age 65, you’ll owe tax plus a 20% penalty.
Maximum contribution amounts for 2020 are $3,550 for self-only and $7,100 for families. The annual “catch- up” contribution amount for individuals age 55 or older will remain $1,000.
What Is a Health Reimbursement Account?
Whereas individuals or employees can fund their own HSAs, only an employer can fund an HRA. When employers offer HRAs, most people benefit from taking advantage of them. With an HSA, you can withdraw funds to pay for approved services and procedures. If you have an HRA, you have to pay the expenses upfront and your employer reimburses you for the cost.
Your employer determines how much to contribute on an annual basis, and it’s important to remember that you can't add your own money to the account.
Employers fund HRAs, meaning it doesn’t cost you anything to participate. Like HSAs, these plans have expansive coverage for numerous procedures, and there aren't any prerequisites on what health insurance you can use it with.
Unlike HSAs, you are not able to contribute to your own HRA account. Also, your employer sets the contribution amount and eligibility rules. If you lose your job, you can't transfer the funds in your HRA account, nor can you roll the amount over at the end of the year.
HSA vs. HRA
Your financial advisor can help you determine your eligibility for a non-employer HSA. However, HRAs are only available under a current employer that offers this benefit. Both employees and employers can fund HSAs, and it might help self-employed workers with HDHPs save on taxes.
You can only withdraw funded amounts in an HSA, but you can withdraw funds from an HRA, even if it's not funded yet. The funds in your HSA stay with you even if you change jobs. Additionally, they roll over year after year. After age 65, you may use HSA funds for non-medical reasons, but these non-medical withdrawals may be taxed. With an HSA, you do have the option to make an early withdrawal, but you may be subject to a penalty. HRAs, on the other hand, do not allow for early withdrawals or for non-medical withdrawals.
Talk to your financial advisor regarding your options as an employee, self-employed worker or individual. Weigh the pros and cons and determine whether you can save money on your yearly medical expenses by enrolling in either of these plan types.
Dream Financial Planning Process ™
Whether you're managing student loan debt, starting a business, or considering buying your first home, the DREAM Financial Planning Process™ is tailored to the unique needs of busy professionals is their 30s and 40s. This process focuses more on short-term goals while you grow and evolve in your personal and professional life. If you're looking for guidance on: Financial Planning, optimizing employee benefits, budgeting, student loans, and managing your 401k or investments we can help.
With uncertainty surrounding the economic stability of our country, it's okay to have fears and anxieties surrounding your own savings and investments. The most productive course of action from here is to reach out to Dream Financial Planning (or whoever your trusted advisor might be) and discuss your options. It's easy to have knee-jerk reactions when it feels like the bottom is falling out, but it is imperative to make decisions using research-backed data and a level head. If you'd like a Complimentary Review and risk assessment of your investment portfolio feel free to send me an e-mail.
On the first Thursday of every month I send out a monthly newsletter with tips and tricks to help you manage your Finances. In the August Newsletter I discuss why I started Dream Financial Planning and the foundational principles of my firm. There's also an article from Time.com about money market funds. If you have questions about what to do with a large cash balance, you might find this article helpful. I've also been getting a lot of questions about how to invest money you'll need in 5 years or less. You can view my thoughts here.
One article from U.S. News & World Report discusses when it might make sense to work with a Financial Advisor and the additional value we can provide beyond just managing investments. I also included two downloadable PDFs. One highlights what you should consider when paying off your student loans. The other provides guidance on Income-Driven Repayment ("IDR") Plans, which can be an attractive option for federal student loan borrowers.
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