Why are HSAs so powerful?

Claiming the HSA is the best retirement account is a very bold claim. Who could forget the mighty Roth IRA with its magnificent tax-free growth? Or how about the Roth 401(k), also with magnificent tax-free growth but higher contribution limits? Here’s why the HSA trumps both of them, when it is at its best.

Contributions to an HSA can be invested, and those contributions grow entirely tax-free, just like with Roth accounts. HSA money can be withdrawn entirely tax free, just like with Roth accounts. The catch is distributions must be used for eligible medical expenses.

Fortunately and unfortunately, most Americans will have plenty of medical expenses to utilize the money in their HSA. A study found that the typical American will spend over $300,000 on medical care over their lifetime. With an average HSA balance of $4,607, it’s safe to say that most Americans won’t have to worry about over-contributing to their HSA anytime soon. Even if you were to have more money saved in an HSA than eligible medical expenses to use it on, you could still use that money for any expenses at age 65 and beyond without penalty. The catch is that money is taxable, so HSA money used for non-medical expenses functions like a traditional IRA or 401(k) without the required minimum distributions (RMDs).

There is one great feature that takes HSAs a step above Roth accounts. Unlike their Roth counterparts, HSA contributions are tax deductible. To summarize, HSAs offer a tax deduction on contributions, assets grow tax-deferred, and distributions for qualified medical expenses are tax-free. This makes the HSA the only retirement account where your contributions may never be subject to federal income tax.

Now that we’re on the same page about how powerful HSAs are, how do you contribute and use them?

How to open an HSA

About 45% of employers in the US offer HSAs to their employees, so you may have access to a Health Savings Account through work. If you do, it could be best to contribute through your job as your contributions will be exempt from FICA tax. Your workplace plan might not have the best investment options, but you may be able to move money from one HSA to an outside HSA after getting the FICA tax break.

You could still be able to open and contribute to an HSA if it is not offered through your employer. If you meet the eligibility requirements to open an HSA, the biggest of which is to be covered by a high-deductible health plan or HDHP, you can open an account on your own without your employer. If you are eligible to open an account and contribute, look for a low-cost provider with a wide range of HSA investment options. There are many providers out there, and one we like is Fidelity for the ease of opening an account and the access to plenty of low-cost investment options.

How to take full advantage of an HSA

Only 10% of Americans even have an HSA, so if you made it this far, congratulations on being in the top 10%! There is still more work to do to fully utilize your HSA and make the most of this extremely powerful retirement account. One big mistake many Americans make is not investing HSA contributions. A study found that only 4% of HSA owners actually invest within their HSA. Doing some quick napkin math, if only 10% of Americans have an HSA, and only 4% of those Americans invest in their HSA, that means about 0.4% of the population is fully utilizing an HSA.

Now you might be thinking, “Okay, I know how to open an HSA and to invest my contributions, which puts me in the top 0.4% of Americans. Surely I’ve reached the pinnacle of HSA usage, right?” Not so fast, friend! Believe it or not, HSAs can be even more powerful if those invested assets are saved for the long-term.

There are two main ways to use the dollars in your HSA. The first is as a slush fund to pay for medical expenses in the present year. If you are using an HSA this way, it won’t make much of a difference if you invest the dollars in your account because they are spent so soon after contributing. The second way to use an HSA is to pay for medical expenses out-of-pocket and invest the money in your HSA and let it grow. That’s because there’s no time limit on reimbursing yourself for eligible medical expenses.

What this means in practice is you can save all of your medical receipts for years or even decades, let the money in your HSA grow, and take those reimbursements in retirement. We don’t know how many Americans use an HSA this way, but it’s certainly less than 0.4% of the population that invests in their HSA.

HSAs might just be the most powerful retirement account available to Americans, but only a small percentage of Americans are taking full advantage of all HSAs have to offer. When used properly, HSAs offer tax-free contributions, tax-free growth, and tax-free qualified distributions. That’s a combination that can’t be matched by any other retirement account available. If you aren’t currently investing for the long-term in an HSA, check to see if you are eligible, open an account through a low-cost provider like Fidelity if you don’t have one through your employer, and save all medical receipts and let your HSA grow for as long as possible.

Investing money in your HSA and saving it for the future may be an optimal strategy, but it does require you to keep receipts for all reimbursable items. How do you overcome this hurdle? Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.

In this highlight, we discuss what you should do if you are not eligible for an HSA or a Roth IRA.

In this highlight, we discuss when it makes sense for you to reimburse yourself from your Health Savings Account.

Is it possible to time your medical expense reimbursements from your HSA? In this highlight, we discuss how to time them and why it matters.

Despite the power of contributing to an HSA, it may not always make sense to contribute to one. You must have a high-deductible health plan in order to contribute, which means you may be paying more out-of-pocket if you experience a large amount of medical expenses. Choosing a plan with better coverage may be worth considering in years where you may have costly medical procedures, surgeries, or when you are expecting the birth of a new child.

How do you know exactly when it might be worth considering getting better coverage? Let’s take a look at a few case studies that show the costs and benefits you will need to weigh.

Scenario One: You are having a baby and deciding between an HDHP and non-HDHP.

Let’s say you are trying to decide between two employer-subsidized health plans, an HDHP with a monthly premium of $200 and a “Cadillac” health insurance plan for $400 per month. You are also expecting a baby in the plan year, which will cost approximately $5,000 out-of-pocket under the HDHP and only $500 under the Cadillac plan.

Choosing the higher cost but better health plan would save you approximately $2,100 if you were expecting a large medical expense like having a baby. Choosing a great health plan may also make sense if you are planning to have an expensive surgery or in general expect more medical expenses.

If your employer offers more than one health plan, and one of the plans is HSA-eligible, run the numbers for yourself to see how the plans compare. It is impossible to know exactly how much you will owe in medical expenses in a given year, but you can at least know which plan will be better for you with different amounts of medical expenses. If you plan to use your HSA as a slush fund to pay for medical expenses, chances are better employer health coverage may be worth considering. If you plan to invest HSA dollars for decades, it could be a tougher decision.

Scenario Two: You are young and healthy with few medical expenses.

Assuming your employer offers the same health plans as above, an HDHP with a $200 monthly premium and “Cadillac” health insurance plan with a $400 monthly premium, here’s how the comparison might look for someone expecting little to no medical expenses in a given year.

Not only is the HDHP $2,400 per year less, you are also eligible to contribute to an HSA. If you invest the $2,400 difference and let it grow for 30 years earning 8%, you would have $26,246 in your HSA. Do that each year for a decade when you’re younger and you’re well on your way to paying for the $315,000 in medical expenses an average retired couple may need to cover healthcare expenses in retirement.

If you are trying to decide between an HSA-eligible health plan or better coverage that is not eligible for an HSA, I highly encourage you to crunch the numbers for yourself. The examples above are almost certainly different from what you anticipate paying in premiums and medical expenses.

Here’s what you need to know to compare the total cost of coverage for different health insurance plans:

• Insurance premiums
• Estimated out-of-pocket medical expenses
• Tax benefits of using an HSA
  • Do you plan to use it as a slush fund or invest it for the long-term?
  • If investing, how long do you anticipate that money will grow?

Better health insurance plans have a huge benefit that may not always show up when comparing the numbers: more coverage. If you anticipate having a low amount of medical expenses, that benefit may not show up when crunching the numbers. However, you can never anticipate exactly what you will pay in medical expenses in any given year, so the benefits of better coverage should not be overlooked.

Choosing a health insurance plan is a decision that should not be taken lightly. Make sure you weigh all pros and cons of having better coverage or contributing to an HSA before making a decision.

Before we get into more advanced HSA strategies, let’s talk about the basics: how do you know if you can open an HSA or contribute? What types of expenses qualify for HSA reimbursement?

Basics of an HSA

To be eligible for an HSA, you must be enrolled in a qualified high-deductible health plan. For high-deductible health plans in 2022, the minimum deductible is $1,400 for individuals and $2,800 for families. The out-of-pocket maximum must be no greater than $7,050 for individuals or $14,100 for families. If you have a qualifying HDHP you still need to check one more box before opening your HSA: if your employer offers an FSA that can be used for medical expenses, you may not be able to use an HSA. However, if your employer offers a limited-purpose or post-deductible FSA, you may be able to use an HSA as well. The primary limited-purpose FSAs compatible with HSAs are for dependent care expenses.

Speaking of employer accounts, if your employer offers an HSA with direct payroll contributions, you may want to consider contributing there instead of through an outside HSA. Contributions through your employer will be exempt from FICA taxes in addition to income taxes, plus your employer may even offer an employer match. If your employer HSA doesn’t have the best investment options, your plan may allow you to transfer funds to an outside HSA with more attractive investment options.

Contribution limits to an HSA in 2022 are $3,650 for individuals and $7,300 for families. If you are 55 or older, you can contribute an additional $1,000 per year as a catch-up contribution. One overlooked advantage of an HSA is that contributions do not need to be from earned income. This means as long as you are enrolled in an HDHP and eligible to make HSA contributions, you can contribute, from whatever funds available to you. If you retire early and don’t have earned income, this benefit can be especially valuable.

What if I only have an HSA for part of the year?

Many Americans switch jobs and health insurance in the middle of the year, so it’s possible you might become HSA-eligible midway through the year. The good news is HSAs have a last-month rule: if you qualify for an HSA by December 1st, you can make the full annual contribution, even though you may have only been eligible for one month. However, you must remain HSA-eligible through December 31st of the next year for those contributions to remain valid. If you violate the testing period, those contributions will become ineligible and taxable.

What if I am no longer in an eligible plan but still have an HSA?

While you are not allowed to contribute to an HSA if not enrolled in a high-deductible plan, you can still spend down existing HSA assets. If you have an HSA but are no longer eligible to make contributions, you can still let your account grow or use it for qualified medical expenses; you are just no longer eligible to make new contributions until or if you become HSA-eligible again in the future.

When should I not use an HSA?

Even if you have the option to enroll in an HDHP and take advantage of an HSA, it may not always be the best decision. High-deductible health plans usually aren’t the most robust plans, so if you expect to have a significant amount of medical expenses, it may be financially optimal to instead enroll in a better health insurance plan or option through your employer. While HSAs are extremely powerful savings vehicles, if your high-deductible health insurance plan is costing you thousands of dollars extra per year in medical expenses, choosing a plan with better coverage may be worth considering. Having good health insurance is especially valuable during those strategic years of large medical procedures and surgeries and in years when you are expecting the birth of a new child.

What expenses can an HSA be used for?

HSAs can be used for a wide range of medical expenses, some that you may not even realize would qualify. IRS Publication 502 covers eligible and ineligible expenses, and when shopping for medical expenses, whether online or in-store, you’ll likely see “HSA-eligible” or “FSA-eligible” tags next to eligible items. There are even entire websites online that only sell FSA or HSA-eligible expenses.

After age 65, or if you are disabled, you can use HSA dollars for non-qualified expenses without being subject to a penalty, although you will be responsible for ordinary income tax. If you use an HSA for non-qualified expenses before age 65, you will owe income tax and a 20% tax penalty. It is best to use your HSA for qualified medical expenses, even after age 65, although if you have an overabundance of HSA assets you can essentially use it like a traditional IRA.

What is the best way to use an HSA?

Using your HSA as a slush fund is not a bad way to pay for medical expenses, as you are still getting tax breaks on those dollars, but there’s an even better way. Paying for medical expenses out-of-pocket and letting your HSA dollars grow is even more powerful since growth and qualified distributions will be entirely tax-free. If you have the cash reserves to cover medical expenses out-of-pocket, your HSA can be an extremely powerful retirement savings vehicle.

Most Financial Mutants know it’s best to save and invest HSA dollars, if possible, but fewer know the exciting rules regarding qualified expenses. There is no time limit for reimbursing yourself for qualified medical expenses, which means you can save your receipts for decades before reimbursing yourself entirely tax-free after your HSA has grown many times over. It is important to keep great records (electronic and physical, in multiple places) if you plan on saving receipts for decades.

HSAs are one of our favorite retirement savings vehicles. They are neck-and-neck with Roth IRAs for the title of “Best Place to Save.” HSAs offer a triple tax advantage; contributions go in pre-tax (reduce your taxable income), growth is tax-free, and qualified distributions are tax-free. As an added bonus, those using an HSA through their employer are exempt from FICA taxes on contributions. Don’t miss out on building these extremely powerful tax-free dollars. Your future self will be so thankful you did!

You’re not going to believe we’re giving away this advice for free! We’re so excited to share these untold secrets and help you take your finances to the next level.

WARNING: These ideas are advanced. While they may be exactly what you need to achieve financial abundance, each step involves complex rules and the IRS. You may not want to try these without a professional.

If these strategies sound like your next step, let us guide you to success! It may be time to take our relationship to the next level as part of the Abound Wealth family.

Here’s what you’ll learn in today’s episode:

Advanced Charitable Giving

• How to use Charitable Gift Funds like a pro
• How to give a larger gift to charity and get a larger tax deduction
• What a “QCD” is and why every non-profit, church, and person over 70 needs to know about it

HSA Fund and Hold

• 3 Ways to Use an HSA (and how most people miss best one)
• The powerful HSA strategy only 4% of people are taking advantage of
• What happens to your HSA if you pass away

Roth Conversions

• How to get the tax advantage of a Roth IRA in spite of the income limit
• The one “catch” to Roth Conversions
• A flow chart that lets you know if Roth Conversions are right for you

Mega Roth Conversions

• How to contribute $50,000 a year to a Roth IRA (We know it sounds crazy!)

Resources and Research Cited in this Episode

• IRS Bulletin (Covering HSA rules)
• Health Savings Account Balances, Contributions, Distributions, and Other Vital Statistics, 2017: Statistics From the EBRI HSA Database

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Should you have a Health Savings Account (HSA)? Fidelity estimates that people 65 years of age till death will require $275,000 to cover medical care costs in retirement. That can leave many of us wondering how to plan and prepare for having that sum of money ready for future healthcare costs.  Fortunately, there is a financial tool that may just be the answer for saving toward healthcare costs in retirement.

Tune in to this week’s mini-episode of The Money Guy Show to find out:

• What is a Health Savings Account (HSA) and how is it different from say a Flexible Spending Account (FSA)
• Who qualifies for opening an HSA
• The three biggest ways an HSA helps you save on taxes – think Triple Tax Advantage!
• What the contribution limits are for 2018
• Why it’s such an efficient sleeper retirement account
• How to select an HSA provider
• Considerations for determining whether or not an HSA is right for you

Tune In and Go Beyond Common Sense with the Money Guys

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