The Best Investment Account You’re Probably Not Paying Attention To!
Maximize your Health Savings Account alongside your 401k or IRA for extra tax advantages.
You may have asked yourself in the past should I be contributing to my Traditional IRA/401k or my Roth IRA/401k. One gives you a tax deduction now and the other gives you tax-free withdrawals later. What if I told you that you didn’t have to decide, that you could enjoy the tax benefits of both?
Our unlikely hero enters as the Healthcare Savings Account, a unique account that offers not one, not two, but potentially three tax advantages. Healthcare Savings Accounts (HSA) were introduced in 2003 to allow individuals with high-deductible health plans put additional dollars away for medical expenses. However, if we turn our attention from short-term medical needs to long-term savings these plans can go a long way to enhancing the health of your retirement plan. Let’s review who qualifies for the HSA and what role these accounts can play.
1. You Must Be Enrolled in a High Deductible Health Plan
Healthcare Savings Account contributions are only allowed in years where you are covered by a High Deductible Health Plan (HDHP). So your first key decision is whether you should enroll in an HDHP or a more traditional health insurance plan. What are the key differences?
In short – an HDHP will have a lower monthly premium, but at the expense of more out of pocket costs when you do need care due to the higher deducible. Remember the deductible is the amount you must spend out of pocket before your insurance starts covering costs. Also of note your HDHP must have out-of-pocket maximums of no more than $7,000 for individuals and $14,000 for families. It is possible to get caught in a trap where a plan is purchased with higher out of pocket maximums which disqualify you from making HSA contributions.
With the HDHP you have access to the HSA. Traditional healthcare plans have the “use it or lose it” Flexible Spending Account (FSA). For 2021 Individuals with an HDHP can make HSA contributions up to $3,600 this year and Families can contribute up to $7,200 (combined employee + employer contributions). If you are over age 55, an extra $1,000 in contribution is allowed.
Which healthcare plan is right for you depends on multiple factors such as you and your family’s own health, likelihood of needing care, and having the cash reserves to cover an unexpected medical expense if one occurred. Your financial planner should be able to look over your options with you during annual benefits reviews and help you decide.
2. Triple Tax Advantages
IRA and Roth IRA accounts each offer two tax advantaged elements. Traditional IRA’s offer a tax-deduction up front on your contribution, Roth IRA’s offer tax-free withdrawals, and both offer tax-deferral of growth while invested (meaning you do not report interest earned and capital gains every year like you would with a regular investment account).
Your HSA on the other hand offers three levels of tax benefits:
- Tax-deductible Contributions
- Tax-deferred growth while your money is invested
- Tax-free distributions when used for qualified medical expenses
It is important to note that if HSA funds are withdrawn for non-medical expenses before age 65 they will be taxed and come with a hefty 20% penalty. If they are withdrawn at age 65 or later for non-medical expenses, you will simply pay income tax on the funds as if they came out of an IRA or 401k. There is no penalty after age 65.
There simply aren’t many other ways to save your dollars from taxation on the way into an account, while they are invested in the account, and on the way out!
3. Free Money (Maybe)
If you have employer provided health coverage, there is a good chance the employer may kick a few dollars into your HSA as an incentive for you to participate. This should go into the calculus of whether the HDHP is a good option for you. An employer match into an HSA can ease the sting of the higher out of pocket costs associated with these kinds of plans. When thinking long-term, it’s also more money that can grow for you over time.
4. Think Long-Term, Not Short-Term
These tax advantages are great, and they are worth so much more the longer they can accumulate. If you have set aside the proper reserve funds to cover medical deductibles, think about allowing your HSA funds to grow for years, if not decades. One day when you’re retired I can assure you this money will come in handy, and you won’t have any trouble spending it. Fidelity has been putting retiree healthcare research out for several years now, and they estimate the average retired couple will need $295,000 in today’s dollars to cover medical expenses in retirement. Your HSA is an ideal way to start creating that bucket of money early.
5. You Can Invest the Money
Many people I meet have been diligently saving into their HSA, but the money just sits, sadly, in the interest-bearing cash account earning next to nothing! Now if you plan to use the money for medical expenses in the short term, cash is king. But, if you’ve read this far and you’re on board with taking the long view with your HSA then please, I’m begging you, see if your HSA provider allows you to invest some or all of your HSA account balance. Most do, and if you are treating this account like a supplemental retirement account you should invest it like one. Your financial advisor can help with the right mix of investments for your needs.
How to get started
If you have decided that an HDHP with an HSA is right for you, then how to get started depends on how you get your health insurance.
If you’re insurance is employer provided, reach out to HR to see if you can begin making contributions to the HSA tied to your insurance plan. If you are not currently enrolled in an HDHP but would like to switch, you may need to wait until open enrollment.
If you are purchasing your health insurance on your own your insurer may offer an HSA, or you can work with your financial planner to open one through one of the many financial institutions offering HSAs. If you’re having trouble fitting an HSA into your financial picture, work with someone like us to review and prioritize your savings needs and see if there is a way to make this kind of account fit into your master plan.
