4 Ways HSAs Help Borrowers on Income-Driven Repayment Win Big

Savings “buckets” come in many forms, but a health savings account is one of the very best ways to capture your earnings over time.

 What makes a Health Savings Account (HSA) so special is that:

1. HSA contributions are pre-tax.
2. HSAs are not use-it-or-lose-it accounts.
3. Investment earnings are tax-free.
4. Withdrawals from the HSA can be tax-free.

The 2024 annual contribution limit for a Health Savings Account is $4,150 for individuals, and $8,300 for family coverage. Individuals who are 55 years old or older are allowed an additional $1,000 catch-up contribution.

As a student loan borrower, particularly one who is on a federal income-driven repayment plan, HSAs offer a handful of benefits beyond covering health-related expenses.

Contributions are pre-tax

If you’re a W-2 employee, by the time money lands in your checking account, your earnings have already assessed federal income tax, usually state income tax, and sometimes local tax. 

Also, for the first $168,600 of income, your 2024 earnings are assessed Social Security and Medicare taxes by the IRS through the Federal Insurance Contributions Act (FICA). FICA for the W-2 individual taxpayer amounts to 7.65% of income under the $168,600 wage base.

If you contribute earnings to a 401(k), you can avoid the above income taxes, but you still have to pay FICA taxes. The contributions are somewhat pre-tax, even though that is the term a lot of financial professionals use for describing 401(k) contributions.

The first really cool thing about contributions to a health savings account is that, like a 401(k), contributions are made pre-tax. You also don’t pay FICA taxes! So on the way into the account, your earnings are truly tax-exempt.

This also means that HSA contributions reduce your AGI, or “adjusted gross income”. If you’re on an income-driven repayment plan, then your monthly payment will be lower as well, thanks to your HSA contribution.

For a borrower with a $150,000 income with a spouse that doesn’t have loans and earns $90,000, their income-driven payment could be $64 per month lower. Extrapolate that over a 25-year plan, and that’s $19,200 in student loan payments you avoided by putting dollars on your side of the balance sheet!

HSAs are not use-it-or-lose-it accounts

A lot of folks are familiar with a flexible spending account (FSA), where the dollars you contribute to that account each year are also pre-tax. However, with an FSA you have to spend most of the dollars by year-end and all of the dollars by the normal tax-filing deadline.

With an HSA account, the account does not have the same stipulations about spending the account down by the calendar year-end or the IRS tax filing deadline. You do have to be covered by a high deductible health plan (HDHP) to select it, but you can keep the money in the account for many years. You could even earmark this account to pay for medicare premiums after age 65!

Investment earnings are tax-free

Just like other investment accounts that allow pre-tax contributions — 401ks, IRAs and taxable brokerage accounts – a health savings account can be invested in open-ended mutual funds, index funds and Exchange-Traded Funds (ETFs). This means your money that was contributed pre-tax, can earn money for you while waiting for those future rainy days for qualified medical expenses.

An HSA gets tax preferential treatment, similar to 401(k)s and IRAs. As you invest it each year, no taxes are assessed on the earnings. This is very different from a taxable brokerage account, where dividends and interest paid each year from investments in the account show up as taxable income on your tax return.

Imagine how those tax-free contributions and tax-free investment growth could stack up over time. If a married couple getting paid every two weeks each contributed $99 per paycheck into their health savings accounts at a 6% return over a 30-year period, those accounts would be worth just over $400,000 😮

Withdrawals from the HSA account can be tax-free

Fast-forward to when you need to spend from your health savings account, and every dollar distributed is tax-free as long as those dollars paid for qualified medical expenses.

Common qualified medical expenses include:

• Medicare Premiums
• Hearing Aids
• Prescriptions
• Dental Office visits
• Eye Exam fees

Healthcare costs represent a pretty large piece of the puzzle in retirement planning. According to a Vanguard study on healthcare costs, the predicted annual expense for a 65-year-old in today’s dollars was just over $5,000.

The cost of healthcare since 1970 has far outpaced inflation, and if it continues to go up at 6% per year, then that annual $5,000 expense roughly doubles every 12 years.

So, if you consider the rising cost of healthcare over time, a health savings account can be a great solution for this eventual pull on your retirement savings.

The ongoing cost for your or your family’s health care today, and in the next couple of years, can be a barrier to getting a cash cushion started in an HSA. One way to approach this is acting as if the account doesn’t exist, and paying for those expenses out of pocket, without any tax benefits. Then, double down and fund the account. 

Benefits of HSA contributions reduce AGI and more

If you’re self-employed and on a HDHP, you can open a health savings account independently through a number of custodians, such as Fidelity, Lively, or Optum Bank.

If you are a W-2 employee, a Health Savings Account may be available to you through your employer. Next open enrollment, you might notice the health savings account option, paired with a high deductible health plan (HDHP).

Now, you’ll recognize it as a way to reduce your adjusted gross income for your income-driven repayment plan in the short-term, and a way to increase your tax-free savings for retirement. Keep an eye out for HSA employer contributions, which are often provided to incentivize employees into choosing a health savings account that goes hand-in-hand with an HDHP.