Tap into the triple tax benefits of an HSA

Did you know that a health savings account (HSA) offers three separate tax benefits? That can make saving for healthcare expenses in an HSA a smart choice now and in the future.

Let’s take a quick look at a family who uses a high-deductible health plan (HDHP) and see how their HSA savings could add up over the first year, and in years to come.

How the triple tax advantage works

1. Pre-tax Contributions
Sally and Steve Seaver have two young children. To help save money for health expenses, they switched to a High Deductible Health Plan (HDHP) to take advantage of the lower premium. Then, to plan for any out-of pocket expenses such as doctor visits or prescriptions, Sally opened an HSA available through her employer’s benefit plan.

By using payroll deduction to fund the HSA, Sally was able to make contributions on a pre-tax basis -- meaning every dollar she contributes from her paycheck is a tax free dollar added to her HSA. By the end of the year, she has contributed $4,000 to the account.

Because their $4,000 contribution is tax-free, this gives the Seavers an additional $1,000 in buying power for medical expenses that they wouldn’t have had without an HSA.

How Pre-tax Contributions Can Provide Savings In Year 1*

navigate to Without HSA Without HSA
$4,000
$1,000
$3,000

*The hypothetical illustration assumes payroll deduction HSA contributions, a 25% tax bracket throughout participation, and does not consider any APR or effective rate of return. Changes in tax rates or tax treatment may impact the comparative results. Please consider your time horizon and income tax brackets, both current and anticipated, when making any decision, as these may further impact the results of the comparison. Hypothetical results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle or account. If you make pre-tax contributions to an HSA, taxes are due upon withdrawal if assets are not used for qualified medical expenses. For amounts invested in mutual funds: Investment return and principal value will fluctuate and when redeemed may be worth more or less than their original cost.

2. Tax-free earnings
Any interest earned on the account is tax free, allowing the Seavers to keep more money to use for medical expenses if they need it. Even with a modest rate of return, earnings can add up and boost money they have on hand to cover their out-of-pocket medical costs. And since they don’t have to tap the HSA until they actually need it, they can watch their money grow tax-free over time.

3. Tax-free withdrawals
Normally, when you contribute money to a tax-advantaged account such as a 401(k) or an IRA, you’re expected to pay taxes on the money once you start making withdrawals. But that’s not the case with an HSA. When the Seavers use money from their HSA to pay for qualified medical expenses, they are not taxed on the money they withdraw.

How HSA savings add up over time

For the Seavers, the triple tax advantages are an important part of a plan to help manage their current and future healthcare costs. If Sally and Steve’s saving and spending rates are relatively consistent over the next 20 years, they could use their HSA to pay for medical expenses during their retirement. For illustrative purposes, let’s look at the following assumptions for the Seavers over the next 20 years:
  • Annual HSA contributions: $4,000
  • Annual expenses to be paid with HSA savings: $2,000
  • Federal income tax rate or bracket: 25%
  • State income tax rate: 0%
  • Interest rate or average annual rate of return: 2.5%
Based on these assumptions, in 20 years the Seavers could end up with over $51,000 in their HSA for medical expenses. With a total contribution of $80,000 (4k per year x 20 years) they could save over $20,000 in taxes over the same time period.

How the triple tax advantage can pay off

Together, the benefits of pre-tax contributions, tax-free earnings, and tax-free withdrawals for qualified medical expenses would add up to significant savings for the Seavers over the course of 20 years. After their withdrawals for qualified medical expenses, Sally and Steve could have $51,089 in their HSA after 20 years. And because they used an HSA, Sally and Steve would have $23,091 in total tax savings.

To see how much your savings could add up over the next 20 years, use our HSA balance and tax savings calculator.

This hypothetical illustration assumes $4,000 annual pre-tax HSA contribution, $2,000 annual withdrawal for qualified medical expenses, 25% tax rate and 2.5% interest rate throughout participation. Calculations for total HSA balance and tax savings accumulated at the end of the 20-year period assume contributions and withdrawals are made in lump sum amounts at the end of each year. Changes in contributions, withdrawals, tax rates and tax treatment of investment earnings may impact results. Please consider your personal situation, investment time horizon and income tax brackets, both current and anticipated, when making any decision as these may further impact the results. Hypothetical results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle or account. If you make pre-tax contributions to an HSA, taxes are due upon withdrawal if assets are not used for qualified medical expenses. For amounts invested in mutual funds, investment return and principal value will fluctuate and when redeemed may be worth more or less than their original cost.

1About Triple Tax Advantages: You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax. Any interest or earnings on the assets in the account are tax-free. You may be able to claim a tax deduction for contributions you, or someone other than your employer, make to your HSA.We recommend you contact qualified tax or legal counsel before establishing an HSA.