Health Savings Accounts: A "Triple Tax Free" Path to Building Wealth
Fun Fact (well.. not so fun), the average American spends $316,600 on medical costs throughout their lifetime. This number is staggering, don’t just sit idly waiting for them to arrive, plan proactively for them. You’ll want to make sure you’re leveraging all the help you can get to prepare for inevitable future healthcare costs.
Well, Good News! To address this challenge of saving for healthcare costs, a special account exists called an HSA (Health Savings Account) that you may be eligible for. This account is “triple tax free” (the only account of it’s kind) and it can save you thousands in paying for medical expenses over your lifetime (if used properly). The HSA is basically a rock star in the financial planning world. For young families & professionals, you won’t want to overlook this account. At a minimum, saving to an HSA can:
1. Save you tens of thousands ($$$$) in taxes over your lifetime on healthcare expenses.
2. Prepare you for high healthcare costs in the future.
3. Create a tax free “healthcare nest egg” you can access today in the event of a medical emergency.
4. and MORE! “More” being laid out in the rest of the blog post :) Read on to learn how you can get the most out of your HSA.
What is an HSA?
As the name suggests, an HSA is a savings account to help you save for medical expenses. But it’s more than that. The money you contribute is pre-tax, similar to your 401K, but that’s not all. The earnings grow tax-deferred as well, and IF you use the funds for qualified medical expenses, your withdrawals are tax-free too! That’s what I mean by ‘triple tax-free.’ With other tax-advantaged accounts, such as a 401k, you either pay taxes on the front-end (Roth 401k) or when you withdraw funds (Traditional 401k). So unlike other accounts, the HSA is fully tax-free at all stages when used for eligible expenses.
An HSA generally consists of two parts, a “cash account” (for shorter term use) and an “investment account” (for longer term use). The cash account is available for immediate withdrawals if you want to pay for medical expenses in the short term, the investment account is the other part of your overall HSA where funds are invested so they can grow for future healthcare costs.
You can open an HSA through an employer if they offer it (and many companies even offer matching) or open your own (for my self employed people).
Who is Eligible?
To be eligible for a Health Savings Account, you must meet these requirements:
· Have a qualified high deductible insurance plan (a “high deductible” is at least $1,400 for a single person or $2,800 for a family)
· Not be on Medicare (not an issue for almost all young families & professionals)
· Do not have secondary medical insurance
· Are not a dependent on anyone’s tax return
· Do not also contribute to an FSA (Flexible Savings Account) or HRA (Health Reimbursement Account) with your employer
What Expenses Qualify for an HSA?
The HSA is meant for health expenses. You’ll receive a debit card that’s linked to your HSA. If you use it to pay qualified medical expenses (which includes dental and vision expenses), you won’t pay taxes on the withdrawal. You can also reimburse yourself (at any time) from the account for past medical expenses paid (as long as they were incurred while the HSA was open and you were eligible for it). Make sure the funds are used for eligible expenses, ineligible withdrawals are subject to a 20% penalty and income tax on which is really high.
Some common examples of acceptable uses of an HSA include:
· Diagnostic appointments
· Ambulance rides
· Prescription medications
· Medical testing
· Chiropractic services
· Dental treatment
· Glasses or contacts
· Lab services
· Hospital services
· Surgery
· Physical therapy…. and even more, these are just some examples.
How an HSA Can Help You Build Wealth:
Save the Maximum to Your HSA:
In 2022, individuals can contribute up to $3,650 to an HSA if single, or $7,300 for a family. There is also a $1,000 catch-up contribution for anyone over the age of 55.
When you have a triple tax free account available that you can save to, it’s wise to give it heavy consideration! While that contribution limit may not seem seem high, if you max it out every year and invest the contributions, it will grow quickly (see below).
Invest Your HSA:
While you are free to spend your HSA funds on qualified medical expenses as they happen, should you? Ideally, the answer is “no” if you’re able to leave the money in there to grow. Why? Two Words: Compounding interest. If taxes are never taken out of the account, that leaves more dollars in the account to compound and grow, letting the account multiply in value more quickly than certain other accounts. When given such a tax advantaged jewel of an account, consider leaving that money alone to grow.
Below is an example showing the power of this strategy: If your family maximizes an HSA ($7,300/year) for 20 years, earning 5%/year, the account would grow to $260,000. At a 30% tax rate, that’s $78,000 in tax savings!!! ($260,000 x 30%) Also, since you never paid tax, that left more dollars in the account to compound and grow your account more quickly. Suddenly, the $316,600 average lifetime healthcare spending for Americans (in the first sentence) doesn’t seem so unsurmountable.
3. Document Your Out of Pocket Medical Expenses:
Proper HSA planning requires you to track all of your out of pocket medical expenses since the HSA was established (prior expenses don’t count) so you can actually use your HSA in a tax-free and penalty-free way. Think of this as a “running tab”. The cool thing is you can retroactively reimburse yourself from the HSA at any time for this “running tab”.
A qualified HSA withdrawal means you are paying for current out of pocket medical expenses directly OR reimbursing yourself for prior out of pocket medical expenses. The planning strategy here is to build up your “running tab” so you have documented proof that you are in fact reimbursing yourself for prior medical expenses. If you can find $5,000 of past eligible HSA expenses you never claimed or reimbursed yourself for, add it to the “running tab”.
Be sure to do proper record keeping of your eligible HSA expenses, if you ever get audited you can rest assured the IRS will want to see documentation to ensure your HSA withdrawals were in fact eligible.
4. Alternative Uses For an HSA: Travel the World or Save for Retirement
Travel the World:
By contributing to your HSA, investing the balance and documenting the “running tab” of eligible HSA expenses, you are essentially giving yourself the flexibility to use the HSA for any reason in the future to “reimburse yourself” up to the “running tab” amount. While the HSA is often best left alone to grow, there is flexibility in how it can be used! Enjoy that dream trip knowing the government essentially paid for 1/3 of it!
Let’s say for example you spend $15,000 on medical expenses while the HSA is open. You can reimburse yourself the entire $15,000 at one time if you like, now or whenever in the future, just make triple sure you have proof so you can show the IRS the legitimacy of the withdrawal. You can then use these funds to travel the world or any other item on your bucket list.
Save for Retirement:
Did you know an HSA can be used like a backup 401k that’s used for retirement living expenses too? After 65, you can use HSA funds for non-healthcare expenses without a penalty, you would just pay income tax on the withdrawal (just like with a traditional 401k). So essentially, an HSA can be used as a “backup 401k” after 65 if you choose to use it for expenses other than healthcare in retirement.
Final Thoughts
A Health Savings Account as a wealth building tool is a powerful way to save for an unexpected healthcare emergency today, future medical expenses tomorrow, retirement, or even world travel if used in the right way. If you have a high deductible health plan, strongly consider opening and funding an HSA every year. Even if you don’t have medical expenses now, you will eventually. Taking this proactive strategy now can save you tens of thousands in taxes over your life and help set your family up for success and financial security in the face of ever increasing healthcare expenses.
If achieving a secure financial future for your family is important to you, schedule a free 30 minute introductory call with me here. Together we’ll look at different ways to proactively prepare for future expenses and review how we can make your money work harder for you. I’m here to help you reach your financial goals so you can live an epic life today, while still being on track for tomorrow.
Jonathan Grannick, CFP®
Wonder Wealth LLC
San Diego Financial Advisor | Fee-only Fiduciary
Disclosure:
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