One of the best things you can do to pay less tax every year is to set up a health savings account and make maximum contributions. An HSA is a tax-advantaged medical savings account available to taxpayers who are enrolled in a high-deductible health plan (HDHP). It is a type of savings account that lets you set aside money on a pre-tax basis to pay for qualified medical expenses. High-deductible plans usually have lower monthly premiums than plans with lower deductibles. By using the untaxed funds in an HSA to pay for expenses before you reach your deductible and other out-of-pocket costs like copayments, you reduce your overall health- care costs.
A health savings account is not the same as a flexible spending account. With the latter you must “use it or lose it” by year’s end. With an HSA, the funds accumulate year to year like a regular savings account. An HSA also may earn interest.
Advantages of an HSA
Disadvantages of an HSA
Although the annual contribution limits are fairly low, it's still worth doing to lower your taxes and increase your savings. The contribution limits for 2022 are $3,650 for an individual ($3,600 for 2021) and $7,300 for a family ($7,200 for 2021). If you’re over 55 you can contribute $1,000 more. (Important note: If you are divorced and your kids have health insurance through your ex-spouse, you can still contribute at the family limit.)
Here’s a scenario to consider: you decide to use the HSA as an investment account to squirrel away money for medical expenses in retirement. In other words, you don’t take any withdrawals for expenses before then. You contribute the maximum family amount every year for 15 years and get a 4% rate of return. After the 15 years, you will have $153,543 to use, tax-free, for your medical expenses, including Medicare Part B and Part D premiums and a portion of long-term-care premiums, depending on your age. That’s significant, especially when it’s estimated that a 65-year-old retired couple will need $260,000 to cover their likely health costs. The money in a HSA can be used to pay those costs tax-free. Accumulating money in a HSA has a distinct advantage over an IRA, since IRA withdrawals will be taxed.
In summary, health-savings accounts amount to a triple play of benefits—deposits are tax-free, withdrawals for medical-related expenses are tax-free, and interest grows tax-deferred. Their major drawback? They have lots of rules and restrictions. It’s fairly easy to set one up; many banks and brokerage firms offer health savings accounts, and you can open an account anywhere as long as you have an HSA-eligible, high-deductible health insurance policy. Finding and getting the health insurance policy is the hard part.