The Pros and Cons of HSAs for Physicians

You’ve probably heard about them in your employee benefit package. Your patients may ask if they can pay with theirs. And your accountant suggested you start investing more money into yours.

Although the term “HSA” is becoming increasingly familiar, many people still don’t understand exactly how beneficial it can be.

A health savings account is an impactful way to reduce medical costs, but as a physician, it’s also an effective way to potentially lower your tax liability.

In this blog, we’ll share the pros and cons of an HSA and cover the alternatives that offer similar benefits.

What is an HSA?

Like so many other things, the cost of healthcare is on the rise. Per the AMA, health spending rose to $4.5 trillion in 2022, a spike of 4.1%, and this rate has been increasing consistently since.

In an attempt to offset the rising expenses of healthcare, insurance companies do what businesses do to keep a profit coming — they raise premiums.

However, to help individuals and families afford healthcare, many companies offer a high-deductible health plan (HDHP) with an HSA option.

The higher your insurance deductible, the lower your premium. But, when you try to use your policy, you must pay for everything until you meet that target amount. Health Savings Accounts (HSAs) cover out-of-pocket expenses before the high deductible is met, reducing the impact on your wallet.

These plans are designed to work with your health insurance plan to offset your out-of-pocket costs. They also offer various other tax advantages when used optimally, which we’ll explain in the next section.

Who Qualifies for an HSA?

The critical factor for an HSA account is that the enrollee must also have a qualified HDHP. Minimum deductible amounts and maximum out-of-pocket costs vary by year.

For calendar year 2024, the IRS defines a high-deductible health plan as one with a $1,600 or higher annual deductible for individuals and $3,200 for families. Annual out-of-pocket expenses can’t exceed $8,050 for individuals and $16,100 for families.

HSAs are available to both employees of companies that offer the benefit and those of businesses that don’t provide company-wide HSA plans. Self-employed workers are also eligible.

Provided you are enrolled in an HDHP, are not a dependent on someone else’s tax return, and don’t have other medical coverage that would disqualify you — such as a flexible spending account (FSA) — you may open an HSA.

How Are HSAs Funded?

Having a secondary plan that covers your healthcare costs until your deductible is met sounds ideal. But those funds must come from somewhere, and that’s where the annual contributions come into play.

HSAs are funded from pre-tax dollars. Contributors could be

• You, as the account holder
• Your employer
• Someone else on your behalf

Contributions are always in dollars, not properties or stocks.

Since the contributed amount is in pre-tax funds, the IRS limits these deductions. For the 2024 calendar year, those with individual HDHP coverage can contribute up to $4,150, and those with family HDHP coverage may contribute up to $8,300.

Employers use health savings accounts as a way to attract and retain quality workers. Businesses can match contributions or choose to commit to a set amount each pay period. This addition to the HSA account isn’t only beneficial to the employee, though — it can also be a tax write-off as a business expense for the employer.

What Expenses Are Covered By an HSA?

Although the HSA plan is intended to minimize out-of-pocket costs until your deductible is met, only qualified medical expenses are covered. These include routine medical costs such as:

• Visits to the medical, dental, or vision office before you meet your deductible
• Any coinsurance or copayments
• Covered medical equipment, such as glasses or, in some cases, braces
• Medications, both prescription and over-the-counter
• Certain medical treatments your healthcare plan may not cover, like chiropractic care

You may have to pay for the treatment first and be reimbursed by your HSA, or you may receive a special “debit card” from your HSA provider to pay for those expenses.

Tax Benefits of an HSA

Maybe you have a savings account with a nest egg you dig into to cover your pre-deductible health expenses. As a physician, a few thousand dollars broken up into occasional bills might not be a big issue.

Yet, the tax benefits of an HSA may be enough to convince you not to ignore this type of savings account just yet.

HSA contributions are tax-advantaged upon entry, growth, and withdrawal. Any funds put into the HSA are provided pre-tax or tax-deductible. Increases in the account’s values grow tax-free if they are withdrawn for any qualified medical expenses.

Because the money you contribute to the HSA is submitted pre-tax, it can reduce your income threshold, moving you into a lower tax bracket. This shift is essential for physicians and others in higher-income professions looking to save money on their taxes each year.

Another benefit is that taxpayers can defer their reimbursements from the HSA until they choose to use them. Deferring withdrawals for medical expenses lets the funds grow, similar to how an IRA or Roth IRA works. These earnings can be withdrawn tax-free up to the amount of the reimbursable medical expenses.

Flexible Advantages and Downsides of an HSA

When it comes to choosing the best ways to save money, an HSA is often at the top of the list, but this type of plan has advantages and disadvantages.

Consider the following facts about health savings accounts before you decide how much to invest in yours.

The Benefits of HSAs

While dipping into your health savings account using the handy debit card you got in the mail can save your wallet in the short term, what happens if you leave that money in the fund?

With no reimbursement time limit, you can pay for the expense out of your pocket, keep the receipt, and then withdraw the money down the road. During that time, the funds in the account continue to compound interest and investment earnings, building your balance — with tax-free withdrawals for eligible expenses.

When you invest in an HSA, you can choose to allocate your money toward stocks, mutual funds, and other options. As your needs change, the pre-tax dollars that go into the account can move up and down, too, up to the maximum contribution limit.

And if you don’t use the HSA funds, they remain in your account, moving with you as you change jobs and continue to earn interest.

Downsides of an HSA

Because employers can easily deduct your contribution from your paycheck, the money goes straight into your employee account. It’s as simple as filling out your initial tax forms for payroll deductions. However, there are some downsides to an HSA.

To begin with, using the tax benefits of this type of account means keeping well-organized, complex tracking records as required by the IRS. You must have proof that your HSA distributions were used to cover qualified medical expenses that weren’t taken as itemized deductions.

Remember that HSA expenses have no time limit, so this requirement also means proving that you never use it as a deduction. Any withdrawals for non-qualified health care expenses can incur a 20% tax penalty, and those expenses will be subject to federal income taxes.

There are also taxes and penalties for early withdrawal. Closing your HSA early and withdrawing the balance instead of rolling it into another HSA or using it for medical expenses incurs a 20% penalty.

After age 65, you can withdraw funds from the account for any reason, but non-medical withdrawals are taxed.

Another downside is that these health savings accounts may have monthly maintenance fees. Your provider may not charge fees if you keep your account balance above a specified minimum, often between $1,000 and $5,000.  Many employers cover this fee for their employees.

Alternatives to HSAs for Physicians

HSAs aren’t accessible to everyone. As mentioned, they partner with high-deductible health insurance plans, so if it’s more feasible for your situation to carry something other than an HDHP, an HSA wouldn’t be for you.

If a health savings account doesn’t seem like the (only) solution to your financial portfolio goals, you have many other options.

Medical Goals

For those who use health insurance frequently or want to limit the impact of their medical bills on their bank account, a health reimbursement account (HRA) or flexible spending account (FSA) could be helpful.

HRAs

Health reimbursement accounts are employer-funded. These tax-free accounts also work in tandem with an HDHP, but the employee cannot contribute.

Instead, the employer contributes based on their rules. The employer determines the guidelines for what happens to unused funds, how they are rolled over, and what eligible benefits include.

FSAs

Many employers offer flexible spending accounts (FSAs) to anyone, regardless of their healthcare deductible. The goal of an FSA is to permit employees to use pre-tax money to cover qualified medical expenses.

Employees choose the annual contribution, which is divided into the year’s pay periods and deducted from each paycheck. FSA funds typically must be used that year and re-enrolled yearly.

Tax Benefit Goals

Your medical expenses may not be significant enough to justify separate spending accounts, or you could have low-deductible insurance such as Medicare. In that case, you may prefer to place your money in a portfolio or retirement account for tax benefits.

The following accounts are known for their tax advantages:

• 403(b)/401(k)/457(b): These plans are funded through tax-deferred contributions and may be employee-matched. Earnings are tax-deferred, and there is no penalty for withdrawal after age 59 ½ (except those who continue working for the plan sponsor of a 457b).

• Traditional and Roth IRA: Traditional IRA contributions are tax-deductible, and withdrawals are taxed as income in retirement. Roth IRA contributions are not tax-deductible, but retirement withdrawals are tax-free. Catch-up contributions for those 50 and older are permitted.

• Permanent life insurance: Investing in a permanent (or “cash value”) life insurance plan turns your monthly insurance premiums into an asset. The policy’s cash value is not taxed, so all interest earned is applied to a growing balance. As long as you don’t withdraw funds, you won’t pay taxes, and your beneficiaries don’t owe death benefit income tax. You can also access cash values through non-taxable policy loans.  There may be estate taxes, but only if the high threshold is met.

• Real estate: Diversifying your portfolio through real estate investments provides you with various tax deductions. Expenses related to maintaining, managing, and operating the property (taxes, insurance, interest, and management and maintenance costs) are deductible. Other costs, such as advertising, business equipment, travel, accounting fees, and office space if you own an agency, may also be deducted.

Note that you may be eligible for any and all of these tax advantages. Talk to your wealth advisor to discuss the right financial plan for you.

Learn more: Financial Planning for Physicians: A Beginner’s Guide

Conclusion

Investments in a health savings account are a wise way to cover qualified medical expenses such as doctor visits and prescription drugs or over-the-counter medication until your higher deductible is met.

However, understanding what your HSA balance is made of and how it is taxed can change how you use those funds.

OJM Group’s experts specialize in healthcare providers' personal finance unique needs. Contact us today to find out if you’re using your HSA optimally and if other plans may help you meet your medical and financial tax savings goals.