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Many people know of the tax advantages that are associated with 401(k) plans and individual retirement accounts, but many aren’t aware of the three tax benefits of health savings accounts (HSAs).
HSAs allow account holders to pay for their current health care expenses while saving for future expenses and have three considerable advantages.
HSAs are tax deductible
HSAs provide account holders with a tax-deductible savings plan that allows one to save pre-tax dollars for future expenses. There are some general guidelines to follow to deduct contributes:
- The full amount of the HSA is deducted from the adjusted gross income.
- In your first year, you can write off the contribution up to the maximum allowable amount if enrolled by December 1 of the current year.
- If it is not the first year of the HSA, contributions are pro-rated.
- Contributions may be reduced if the employer contributes to the account.
HSAs allow tax-free withdrawals
The savings in an HSA can be used tax-free before retirement for qualified medical expenses for the account owner, their spouse or dependents, even if they are not covered under a required high deductible health plan. After the age of 65, you can withdraw penalty-free for any purpose. You will pay income tax on the withdrawal if it is not used to pay for health care.
HSAs earn tax-free interest
Unlike FSAs, there is no “use it or lose it” clause for an HSA, which means that unspent funds can remain in the account year after year. There are no limits as to how much you can accumulate in your account.
Like an IRA, the interest of an HSA is tax-deferred. If you are under the age of 65, the money must be used for health expenses only, with ineligible expenses resulting IRS penalties. If all the money in the account is spent on qualified medical expenses, taxes are never owed on the accrued interest.
And, unlike banking accounts that generate interest income, that interest stays in your account until you are ready to use it for health care expenditures.
With the flexibility of an HSA compared to IRAs, 401(k)s and the like, it is evident why some are contributing to an HSA as a retirement savings strategy.