“HSA Magic” — Understanding Tax Benefits of HSAs

It’s magical . . . how much you save!

The Health Savings Account (or HSA) is a tax-advantaged savings/retirement account similar to a traditional IRA or 401(k) plan, only better! Money goes into the account on a tax-deductible basis and grows tax-free. Unlike the traditional IRA or 401(k), money is not taxed on withdrawal to pay current and future healthcare expenses.  This “triple tax benefit” enables HSAs to be the best way to pay for current and future health expenses.

With a traditional health plan, the employee pays their portion of medical bills with ”after tax” dollars.  When paying a bill with an HSA-based plan, the employee pays with pre-tax dollars.  That’s a little like comparing apples to oranges.  There is a common denominator for comparison: how much does employee need to EARN in order to pay a medical bill.

Important Note: The magical moment occurs when employees realize that paying with tax-free dollars is often nearly as good as copays. And, paying the out-of-pocket maximum for large medical expenses with pre-tax dollars is often dramatically better than paying a comparable out-of-pocket maximum with after-tax dollars for a traditional health plan.

Vital info: The basics of payroll taxes

When an employee earns wages, the employer is required to withhold Federal taxes as well as Social Security and Medicare taxes (FICA), amounting to nearly 33% for the average worker.

View this chart to see what the withholdings look like for single filers earning $36,901 to $80,350 and/or married filers earning $73,901 to $148,850. According to the chart, for every $100 earned, the employer is required to withhold $33 in taxes.  The employee is left with $67.

The 50% Rule of Thumb:  To compute how much you need to earn to pay for anything (tv, car, or medical bill), add 50% to the bill.

• If a plan member with a traditional plan reaches an out-of-pocket maximum of $6,000 that member will need to earn $9,000 considering a Federal tax withholding of 33% or $3000, in order to pay the $6,000 medical bill.
• If plan member has an HDHP coupled with a Health Savings Account, that member will only need to earn $6,000, payroll deduct that money tax-free into the HSA, to pay the $6,000 medical bill.

Clearly, having to earn $6,000 is much better than having to earn $9,000!

To read more about HSA Magic, click here to read “The Case for HSAs: Why nearly everyone can benefit from owning a health savings account” by Robert Hopper, Ph.D.  This article was published in the national journal for insurance agents December 2015, and illustrates how for most common medical scenarios, the HSA-based plan coupled with an HSA outperforms a more expensive Silver plan. It is even more valid than gold and platinum plans.