Health Savings Accounts and the Triple Dip
If you don’t know what a health savings account (HSA) is, then you probably don’t have one and aren’t qualified to have one. The HSA was created to accompany only high deductible US health insurance policies. The idea seems to have been that if you have to pay $2,000 or $4,000 in out-of-pocket medical expenses this year before insurance kicks in, then you should be allowed to save a chunk of money each year to cover that high deductible.
That may have been the intention, but a few creative financial minds have come to the realization that the HSA could be much more than advertised. For those who have good health and can afford to let some money sit in their HSA year after year, it has become a go-to investing vehicle that offers an unheard of triple dip of tax advantages.
1. Untaxed Income in the USA
Like a Traditional 403b or clergy housing allowance, your HSA contributions are deducted from your paycheck before taxes are subtracted. It is a pretax benefit. This alone is of value to the American tax payer.
2. Untaxed Growth in the USA
Any growth in your HSA accumulates tax-free as long as it stays in the account. Interest, dividends and capital gains will not be taxed. If you are confident that you will not have to access those funds for at least a few years, it is probably advisable to invest your funds in an aggressive, low-cost mutual fund.
If your HSA doesn’t offer an investment option, there is nothing wrong with just enjoying some tax-free interest. However, more and more HSAs are growing wise to the utility of the account as an investment and, thus, offering suitable investment options. In the case of larger balances, it may also be with transferring your balance to a firm that has an investment option and can receive your funds. Your organization will continue to fund the existing account, but at least the balance of your HSA dollars will be – we hope – enjoying stock market gains without being subject to US taxation.
3. Untaxed Withdrawal in the USA on Current or even Past Medical Expenses
So this is the kicker that surprised a lot of financial gurus. As long as withdrawals are used for medical expenses (which include things like contact lens solution, dental cleanings, etc.), they will not be taxed.
Earnings on your pretax, Traditional 403b will be taxed upon withdrawal. Your Roth 403b funds were taxed before being put away. And both usually have high penalties if you try to touch the gains in those funds before retirement (outside of a few exceptions).
The HSA is special. If you follow the rules, you pay no US income tax when the funds go in, as they grow, or even when they come out for medical expenses. That’s the triple dip!
It is important to note that you won’t forfeit unused funds at the end of the year or even at the end of a decade. The funds don’t expire and your medical expenses can be reimbursed whenever you choose. If you want to put your receipt for your prescription glasses in an envelope for 20 years before asking for the reimbursement, Uncle Sam will let you. Or, when you age and presumably have higher medical expenses, you can reimburse those future and past expenses from your HSA that has potentially grown significantly over the last 20 years.
So, for some investors/savers, this fund created with your health in mind has become a significant retirement tool as well. The triple dip is a really big deal.
There May Be a Catch for Expats
You will have no doubt noticed how often I mentioned “untaxed in the US.” Are things ever really that simple for expat humanitarian aid workers, missionaries and the like? Of course not!
It is my conviction that we are generally tax residents of the country in which we live. Thus, we need to ask ourselves and our foreign tax preparers how the HSA might be taxed. Most countries that tax your income will probably also tax your HSA contributions as they go in via your paycheck. There goes the first dip. Frankly, that’s not a big deal.
Some countries might conceivably tax your earnings each year because HSAs weren’t really foreseen by the tax treaties. This seems unlikely, but it could happen. That might do away with the second dip. This probably isn’t a big deal either.
The worst scenario might just be that they will tax your entire withdrawal amount (what you contributed and the earnings) as you withdraw them. That would be the third dip. Losing that would really hurt.
Why is this the worst scenario? Well, it may very well be that your contributions to the HSA will be taxed going in, your gains will be taxed a bit year by year, and then any withdrawal will be taxed as income. That’s right, it’s possible that the HSA – which was designed to save you tax dollars – could actually cause you to be taxed twice on the same dollars.
A Possible Partial Solution
If you feel that the foreign country in which you live will be taxing you in this way, you might want to put off making these withdrawals until you move back to the US. Remember that, unless current laws change, HSA funds can be withdrawn for past medical expenses in the US. You could hold on to those receipts for 20 years until you are possibly no longer living in a foreign land.
That, at least, appears to be a possible solution to me. It should preserve at least your third dip which is by far the most important of the HSA triple dip.
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