One of the most underutilized tax strategies by small business owners is the use of a health savings account (HSA). Not only is it a flexible tool for helping to pay for current and future healthcare costs, but it can be a fantastic tax-savings strategy as well. Everyone should at least consider the HSA as an option when purchasing insurance during the enrollment period, which runs from November 1, 2015, to January 31, 2016.
Essentially, the HSA is much like an IRA that operates as a tax-favored savings account for healthcare. The only requirement to qualify for one is that you have a qualifying high-deductible health insurance plan.
Once you have the proper insurance, HSA contributions can be valid deductions on the front page of a taxpayer’s Form 1040. Account balances grow tax-free, and distributions can be used immediately—and tax-free—for qualifying healthcare expenses. If you don’t use the saved money for healthcare, you can use the HSA like a typical IRA after age 59 ½.
To know what medical expenses qualify under an HSA, check out the long list in IRS Publication 502.
Benefits of an HSA
Created by Congress in 2001, HSAs are perfect for individuals or families who consider themselves “generally healthy,” and can afford the risks and costs of a high-deductible insurance policy. Here’s a sampling of some of the benefits of HSAs:
Save on Taxes
Not only are HSAs pre-tax accounts, but contributions to them are deductible from your gross pay amount. Since contributions can be deducted on the front page of your tax return, an HSA could potentially put you into a lower tax bracket.
Spend the Money on Qualifying Expenses, Tax-Free
As long as you’re using the money for health expenses—and odds are good that there will be more of them when you’re older—your HSA could essentially act like a Roth IRA, in that Roth withdrawals made after retirement are not taxed.
Save Money on Insurance Premiums and Healthcare Costs
HSA-qualifying health insurance policies generally carry lower premiums, which can save your business’ hard-earned profits. Moreover, the ability to pay cash for healthcare costs allows you to negotiate for lower cost services. It might also motivate you to be more healthy.
It Can Help Pay for Your Retirement
After you turn 59 1/2, there’s an option to make withdrawals for non-healthcare expenses, on which you’ll pay federal income taxes. If you opt for this choice, the HSA then acts much like a traditional IRA, since the HSA holder pays ordinary income taxes on non-medical related withdrawals. There’s also the added perk of not being bound by mandatory disbursements usually required by traditional IRAs.
It Can Be an Investment Vehicle
HSAs allow you to invest the money in much the same way you invest an IRA. You can even invest HSA funds in real estate. So, in a sense, your healthcare savings could also help you buy a rental property.
It’s generally advisable, however, to stick to more with liquid investments if you have a health condition or are at risk of developing one. You want the money available in case of a medical emergency, which means you likely want lower-risk investments.
Is There Anything Else I Need to Know About HSAs?
Again, the only catch to qualify for the HSA and get a deduction during 2016 is that you have a high-deductible health insurance policy (HDHP) in place before the enrollment period is over on January 31st.
Providing sufficient healthcare is not just about having a smart business sense. It can also be a smart tax choice. Before you make that decision, however, consult your team and review your financial statements to see if choosing an HSA-qualifying plan makes sense for your business.