Health Savings Accounts – The Tax Planning All-Star

July 23rd, 2021 by Jim Allen

When it comes to saving on taxes, the “Holy Grail” is a vehicle that is considered triple tax free. This means that:  (1) contributions would be tax deductible, (2) earnings would grow tax-deferred, and (3) distributions would come out tax-free. I have specialized in the advanced tax planning arena for a large part of my 35 years as a financial planner and have seen a huge variety of tax schemes that proposed to meet this “Holy Grail” standard. Unfortunately, almost all of them were not legitimate and people ended up with extra taxes, penalties and sometimes even jail time. The IRS takes the sanctity of our tax system very seriously. So, if you are pitched a program that purports to provide a triple tax benefit, be very careful.

Generally, tax benefits are provided so that people have an incentive to do something for the common good. For instance, the Government wants you to give to charity or to buy a home, so they give you a tax deduction.

They also want you to save for retirement, so they provide a tax deduction for IRAs and 401(k)s while allowing the money to grow tax-deferred until retirement. But, they also want to collect their tax at some point, so they force you to take the money out starting at age 72 and then tax the distributions. Roth IRAs also get two out of the three tax benefits but in the reverse order. While contributions are taxed, earnings grow tax deferred and distributions are tax-free if certain requirements are met. Again, two out three isn’t bad.

But there actually is one legitimate vehicle that provides this triple tax-free benefit. It is called a Health Savings Plan or HSA. It truly is the Holy Grail of tax planning, but there are substantial limitations on how you can use it.

An HSA is a tax favored savings account designed to be used to pay for medical expenses. Contributions to an HSA are tax-deductible subject to certain contribution limitations, and the earnings in the HSA grow tax-deferred. Finally, if you take money out of the HSA to pay for qualified medical expenses, the distributions are tax-free. It may sound too good to be true, but it isn’t.

So there has to be a catch, right? Yes, there are several. First, to contribute to an HSA you must have what is called a “high deductible health plan.” This is a medical plan that doesn’t kick in until you have incurred a certain level of medical costs ($1,400 deductible for single people and $2,800 for families). The concept is that you can save funds in the HSA to be used to pay these deductibles or for other costs not covered by the plan. You also cannot be enrolled in Medicare.

Next, if you have a plan that is an HDHP, there are annual contribution limits, which for 2021 are $3,600 for a single person and $7,200 for a family. If you are over 55, you can contribute an additional $1,000 as an annual catch-up. You can make the contributions, your employer can or a combination of both. There is also a one-time opportunity to roll an annual contribution amount from your IRA to an HSA. Once you are enrolled in Medicare, you can still use your HSA but cannot make any more contributions. With these limitations, you are not going to accumulate a substantial amount of funds unless you start contributing very early in your employment career.

The final catch is that distributions are only tax-free if used for qualified medical expenses. While the list of qualified expenses is quite long, if you do not use the funds for these expenses, you will pay income tax on the growth in addition to a 20% penalty. However, the 20% penalty goes away at age 65. Once you are 65, if you do not use the HSA funds for medical expenses the tax treatment is essentially the same as an IRA.

So, there are some limitations on using an HSA: you must be in an HDHP, you have contribution limitations, and you must use the funds for medical expenses in order to receive tax-free treatment. However, the HSA can be a great tool for accumulating money for future medical expenses.

The HSA is extremely flexible and a great way to pay current and future medical expenses in a tax favored manner. It truly is the Holy Grail of legitimate tax planning tools. If you would like to discuss if HSAs fit into your financial plan, please contact our office for a complimentary consultation.

While we are on the topic of tax planning, please make sure to sign up for our upcoming webinar: “Tax Hikes on the Horizon – Myth or Reality.” The webinar is Wed. August 4th at 6 pm. You can register on our website at

Jim Allen, CFP, ChFC, EA, CDFA is President, Sr. Advisor and a Principal at Anchor Bay Capital. In addition to his 30+ years of financial planning experience and his professional credentials, he holds a Master’s Degree in Financial Planning and is a former instructor in the CFP program at the University of California Irvine. He is also the co-author of the book “The Tools & Techniques of Charitable Planning.” Jim can be reached at [email protected]