Self-Employed HSAs: How entrepreneurs & freelancers can use HSAs

Contract work, freelancing, moonlighting -- whatever you call it, the way the world works is changing in a very big way. Lately, more and more people are choosing to leave traditional workplaces and pursue self-employment because of the freedom they have to choose their work environment, set their own hours, and maybe even add a little more variety to their chosen profession.

Plus, with the exponential growth of connectivity, it's easier than ever to stay connected to companies and clients remotely. This increased focus on contract work means workers have a lot of new career options, while companies can hire the right people for their needs… not just the best people within driving distance.

How does this relate to our goals for this guide? Unlike FSAs, which require employer-sponsored health plans, freelancers are eligible for HSAs. Not only can they help users pay for out-of-pocket medical expenses and everyday health products, but they also give you a distinct triple tax benefit:

  • The contributions you make to your HSA are tax-free, similar to contributions to your 401(k) retirement account, traditional IRA or other interest-bearing account. The lower your adjusted gross income (AGI), the lower your taxable income.
  • The interest you earn from your HSA dollars grows tax-free.
  • When you make withdrawals for qualified medical expenses, those withdrawals are also tax-free.

So... what's the concern with becoming an entrepreneur?

Basically, leaving the traditional workforce for an increasingly competitive freelance arena means dealing with the lack of security and stability that comes with it. While there are plenty of health insurance options available to gig workers, the medical and retirement benefits that come with a full-time, salaried role are still more desirable.

For many people making the leap to self-employment, their health care insurance coverage may not be at the top of their pros and cons lists. But if you're an HSA owner, you can breathe a little easier on your journey into the independent workforce. If you had an HSA with a previous employer, you can make the leap to independent employment with money already saved for health care needs. It might not be ideal, but it's your money to use for medical costs -- whether it's for in-office visits, bandages or advanced hi-tech health products -- as you see fit.

HD-What? Overview of HDHPs and HSA-eligibility

While HDHPs can sound scary, they can save you money in the long run. Many younger consumers are even opting for HDHPs to lower premiums on health care.

We'll take HDHP enrollment step-by-step , from opening an HSA to budgeting for expenses, to even learning how to negotiate with medical professionals. Follow these tips and you'll be well on your way to both physical – and financial – health.

Become a savvier health care consumer

These days, consumers are looking to get the most bang for their health care buck, and are shopping around for the plan that best fits their needs.

Become a better health care consumer by taking advantage of tax-free accounts like HSAs. As always, do your homework. While an HSA is a great way to offset the cost of an HDHP, not all health plans will leave you eligible for one.

Shop around for health care. Providers, out-of-pocket costs, copays, and other related costs - these can cost you big if you haven't met your deductible yet, so you'll want to be smart with your spending. You may choose to visit a cheaper provider, then use those extra funds to pad your savings, invest the money, or even splurge on a health-focused bundle of products.

Negotiate your medical bills. Educate yourself on what specific procedures or specialist visits should cost, then call your provider and offer something in that range. Many providers are more than willing to negotiate.

Worth noting

Ask before you pay, since getting any funds recouped will likely be tougher than simply paying less up front. It also pays (pun intended) to know how to effectively communicate with health care professionals. In other words, be nice!

  • Buy generic. From monthly medications to OTC purchases, buying generic can save you a ton of cash. And when you're footing the bill of a higher-than-normal deductible, you may not notice the difference between brand name and generic, other than the name on the box.
  • Get a primary care doctor. While this may seem opposite from the advice we gave above, having a primary care doctor you know and trust is invaluable in saving money on health care. Primary care physicians are almost always cheaper than trips to urgent care centers or emergency rooms, and they're a great sounding board for all your health care questions.

Open an HSA

You know you saw this coming. Opening an HSA is one of the smartest things you can do when enrolled in an HDHP. Not only does the tax-free account help offset the cost of health care, the funds also roll over year-to-year and can be used, penalty-free, for non-medical expenses after age 65 (income taxes apply).

Plan ahead to put some dollars aside for out-of-pocket medical expenses so that you're prepared for any unforeseen major medical events. If you have cheaper health care costs that year? No worries. Your money carries over year to year. And it comes with you when you change jobs.

Also, don't overspend! Make an annual budget for your HSA so you don't end up short at the end of the year.

Keep an eye on your deductible

While trying to cut corners on care may be tempting, this may work against you if enrolled in an HDHP. After all, once you hit your deductible, you're 100% covered for the rest of the year.

So watch your deductible and time it correctly. Keep in mind that HDHPs require a minimum deductible of $1,400 for an individual and $2,800 for a family, with an out-of-pocket maximum limit of $6,900 and $13,800 in 2020.

With an HDHP, it's all about balance. Before enrolling in an HDHP, it's wise to consider how large of a deductible you can afford. While this cost might sting at first, if you can hit it in the first half of the year, you're better off, since you'll be covered the remainder of the year. But if it won't be until mid-December to meet your deductible, you'll be scrambling to get all those last-minute dentist, optometrist, and yearly physicals in afterward.

If you've been contributing regularly to your HSA with the funds you've saved with a lower monthly premium (an attractive part of most HDHPs) however, you should have a nice little health care rainy day fund.

Consider add-on benefits

You may consider add-on benefits to supplement your HDHP. These are basically "add-on" health care perks, also called voluntary benefits, that you pay for yourself and can use to help round out your health care coverage.

Examples include vision and dental coverage not provided by your employer or a supplementary life insurance policy.

  • Dependent Care FSA - a tax-advantaged account used to pay for the care of any dependents, such as day camp/daycare for children or daycare for dependent adults.
  • Limited Purpose FSA - These regularly go hand-in-hand with HSAs and this specialized FSA covers things like dental and vision or coverage for dental and vision over-the-counter products.

Anticipate your health needs

If you're single and healthy, the money saved each month in an HDHP can go toward living costs and savings goals. While you can't really predict if and when you'll get sick, you can figure out what routine or preventive care you'll need like annual check-ups every spring, and lab work to make sure things are going well.

If you require more frequent doctors' visits or prescription and OTC medications, you'll want to budget accordingly.

Pro Tip: If you have prescription medications, see if you can order them in bulk. It could net you a discount.

Because funds in your HSA roll over (you don't need to spend all the funds in your account by the end of the year, like with an FSA), you don't have to feel rushed to get your balance to zero by a deadline.

Healthy spending choices

Use it as a financial cushion

Freelancers tend to be used to feast or famine with how much money they're bringing in. During the less-productive times, tap into your HSA to pay for out-of-pocket medical expenses. You can also use it to purchase qualifying health items that you might use on a regular basis. What you can purchase with funds from your HSA could surprise you.

Sync up spending with the ebb and flow of freelance work

If you're having a slow month, you can tap into your HSA funds to pay for eligible expenses. As an example, if you live in Florida, you might need sunscreen year-round, which is eligible, as long as it's SPF 15+ and broad spectrum. Plus, you can purchase pain relief products (when prescribed), eye care and lens wipes, and even advanced diagnostic products -- they're also typically eligible expenses.

But, if you're having an awesome month income-wise, consider putting a bit extra into your HSA. That way you'll have it tucked away during the slower periods.

For those participating in their HSA-qualified health plans as individuals, the contribution limits for 2020 will be $3,550 a year, and $7,100 for those participating as a family. If you're age 55 or older, you can add an extra $1,000 to those limits as a "catch-up" contribution.

Contributing to an HSA as a sole proprietor

Since you file taxes on your personal tax return, you're essentially treated like someone making HSA contributions on their own. While you are not able to contribute to an HSA pre-tax throughout the year, you are able to deduct some of your contributions on your personal income tax return.

The good news is, as long as you made a profit during the tax year (go you!), you can file the deduction. The tradeoff is that you can't put more in your HSA than your net self-employment income.

Unlike traditional employees that contribute to their HSA with pre-tax income dollars, you would contribute after-tax dollars to your HSA and then do a line item deduction in your Schedule C. To make sure you're getting everything right, it's best to consult a tax professional on these matters.

If you have an LLC...

As a single member LLC, you're not going to treat your HSA much differently than a sole proprietor. Though, if you have employees, you may be able to implement a plan that can allow those employees to make pre-tax contributions. This is what's known as a "cafeteria" or "Section 125" plan.

The downside is that, as the owner, you can't participate. You can only contribute after tax dollars and it's counted towards your personal taxes. So, whatever you contribute towards your HSA will reduce your adjusted gross income. Just like a sole proprietor, you can only claim this deduction if you actually made a profit.

Tax implications

Freelancers often work to reduce their taxable income by as much as possible each year through deductions, expenses and even end-of-year capital expenditures. An HSA can become part of a strategy to reduce taxable income while saving money for health expenses that can be used tax-free at any time.

For all other expenses, we encourage patience. Before age 65, tapping into an HSA for non-qualified withdrawals comes with a steep 20% penalty, plus that money becomes taxable. So you might want to hold off on that vacation. But once you turn 65, this money can be withdrawn penalty-free for any reason (income taxes apply).

Being 65 might seem far in the future for many freelancers, but putting money into an HSA that doesn't get spent on medical expenses eventually turns into a tax-free retirement savings account.

We understand that leaving the traditional workforce for contract work can be daunting. Gig workers can face the challenge of keeping up with multiple clients, tracking payments, and dealing with a more haphazard work schedule than even those who own small businesses.

But with an HSA as part of your health care and savings plan, your physical and financial well-being doesn't have to add to the stress.

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