Tax Advantages to Look Out for in HSAs

Tax advantages and other key benefits of health savings accounts share many similarities with those of 401(k) plans, according to experts speaking Wednesday at the PLANADVISER/PLANSPONSOR 2023 HSA Conference.

If the most basic benefit of a defined contribution retirement plan is to gain a tax advantage on long-term investments, then health savings accounts can serve a very similar purpose, according to Jake Spiegel, a research associate at the Employee Benefit Research Institute, said on a conference webinar titled, “Understanding HSAs.”

“An HSA is an incredibly flexible, tax-advantaged account relative to a 401(k),” Spiegel said. “Contributions are made on a pre-tax basis like a traditional 401(k). Distributions for qualified medical expenditures are also tax-free, sort of like a Roth 401(k).”

Investments within HSAs grow tax-free, and contributions made through payroll deductions are not subject to FICA taxes, Spiegel said. “You get an additional 7.65% tax break in contributions if you’re subject to FICA tax,” he noted.

Spiegel said a noteworthy benefit of HSAs is that users can be reimbursed for an expense incurred in a previous year, provided the HSA already existed and the user still has documentation. One wealth-maximizing strategy is to pay for medical expenditures out of pocket as they are incurred, then submit for reimbursements for previously incurred medical expenditures when retirement spending needs arise.

“Health care spending for couples in retirement can be pretty substantial,” said Spiegel. “We’ve done some modelling that suggests for couples that have very high prescription drug expenditures, couples that are facing relatively high health care cost in retirement may need as much as about $380,000 to cover all of their medical expenses in retirement. HSAs can go a long way to offset that pretty significant health care cost burden in retirement.”

Steve Durso, associate director of benefits accounts at Willis Towers Watson, noted that some employers also contribute to HSAs just like 401(k)s. He said it is very common for an employer to contribute an HSA seed, and some companies offer a 401(k)-like match.

Durso pointed out other similarities, including catch-up contribution capability. “I think a lot of people know that 401(k)s and 403(b)s allow catch-up contributions starting at age 50,” he said. “For HSAs, it’s age 55, and if you’re 55 or older, you can actually contribute an extra $1,000 toward your HSA for the year.”

Saghi Fattahian, a partner in Morgan, Lewis & Bockius LLP, said the tax advantages are true for any type of contribution, whether it is made by the employee, the employer or as a catch-up. The tax implications are the same, as long as a participant is being reimbursed for medical expenses, which are 213(d) expenses under the Internal Revenue Code.

“If you do reimburse yourself for an expense that is not a medical expense, it would be subject to income taxation,” Fattahian said. “It would be inputted as income, and you may have potential penalties to pay associated with that reimbursement. But you can also invest the dollars you have in your HSA so those dollars can grow like they would in a 401(k) plan.”

Overall, if used correctly, there are a lot of “similarities with regards to HSA contribution and how it works on the defined contribution side with 401(k) plans,” Saghi said.