There are certain savings plans many people are familiar with. Many folks, for example, have heard of a 401(k) or IRA.
But HSAs, or health savings accounts, are less well-known. And that's a shame because these plans offer a world of benefits to those who are eligible for them.
That said, at the end of 2022, HSA balances rose about 12% on a year-over-year basis, reports Bank of America. And the average individual account balance grew from $3,931 to $4,397 during the first six months of 2023.
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If you've been on the fence about funding an HSA, it pays to learn more about how these accounts work. Chances are, you'll want to jump at the opportunity to enjoy a universe of tax savings.
A world of benefits
Traditional IRAs and 401(k) plans give you a tax break on your contributions, but you'll eventually pay taxes on your investment gains in your account. And withdrawals are taxable in retirement. Roth IRAs and Roth 401(k)s offer tax-free gains and withdrawals, but contributions are made with after-tax dollars.
HSAs combine these benefits to give savers the best of all worlds. HSA contributions go in tax-free, investment gains are tax-free, and withdrawals are tax-free when used to pay for qualified medical expenses.
Furthermore, HSAs are extremely flexible. You can carry your money forward as long as you like -- there's no pressure to spend down your balance at any point. In fact, HSAs are set up to encourage you not to spend your plan balance every year so you can invest that money, instead.
As you might imagine, taking an HSA withdrawal for non-medical purposes will result in a penalty, the same way penalties apply when you take an early withdrawal from your IRA or 401(k) plan. But once you turn 65, you can tap your HSA for any reason without penalty.
The only thing that'll happen is that your withdrawal won't be tax-free if it's not used for medical expenses. But that still gives you plenty of leeway to use your money as you please later in life.
It pays to participate in an HSA
HSA eligibility hinges on being enrolled in a high-deductible health insurance plan. It pays to see if your current plan qualifies. If it doesn't at present, there's always a chance you'll be able to save in an HSA next year.
We're getting closer to the point in the year when employees have to make decisions about open enrollment. You may be asked to sign up for 2024 health benefits as early as October, at which point you should compare your health plan options and see if opting for a high-deductible insurance plan makes sense.
Some employers give employees money toward their HSAs when they enroll in a high-deductible insurance plan. So going that route may be just as cost-effective as a lower deductible plan, only it opens the door to making HSA contributions and getting to enjoy a world of tax benefits in the process.
