Several investment vehicles offer significant tax benefits, and the Health Savings Account (HSA) is a prime example.
If you haven’t heard of HSAs, they are tax-advantaged accounts that allow contributions of pre-tax income for qualified medical expenses, with tax-free withdrawals. You can contribute up to $4,150 annually for individuals or $8,300 for families, with an additional $1,000 catch-up contribution for those 55 and older. However, eligibility requires participation in a high-deductible health plan (HDHP). To qualify for the family limit, your family members must also be covered under the HDHP.
So, how does an HSA impact your wealth creation? By contributing for qualified medical expenses, you avoid taxes on income you would have otherwise paid. But what truly sets HSAs apart is the ability to invest your contributions and grow them tax-deferred over time. Similar to other tax-advantaged accounts like IRAs, your contributions grow tax-free. However, unlike IRAs, HSA funds used for qualified medical expenses are not taxed upon withdrawal. This is the HSA’s triple-tax advantage: contributions are tax-deductible, growth is tax-deferred, and qualified medical expense withdrawals are tax-free.
Medical expenses are a major expense for retirees, making HSAs a significant tax-saving opportunity. To cover the same medical expenses out of retirement savings, you might need 15-30% more saved if you weren’t using an HSA.
A common mistake for HSA holders is using contributions for routine medical expenses during their working years. While that’s a valid use, it sacrifices the opportunity for substantial growth by not investing those funds. Most households with the ability to save for HSAs can likely cover routine medical expenses with regular income or existing savings. Missing out on this growth hinders wealth accumulation.
Another unique feature of HSAs is the ability to reimburse account holders for previously incurred medical expenses. The HSA must be opened before the expense is incurred, but by using income for medical costs during your working years and reimbursing yourself later, your HSA funds can grow significantly over time. Keeping receipts and reimbursing yourself later creates tax-free liquidity opportunities, further diversifying your retirement portfolio’s tax treatment.
A concern for some is that HSAs are primarily for medical expenses. What if you contribute heavily but don’t have major medical costs in retirement? Here’s why HSAs are still valuable:
- The later years of retirement often see the highest medical expenses concentrated in a short period. HSAs help prepare for these unforeseen costs, such as long-term care.
- Retirees can withdraw funds from their HSAs for non-qualified medical expenses without penalty, but only after age 65. These withdrawals are taxed as income, similar to traditional IRAs. This flexibility provides peace of mind about HSA liquidity and lets you supercharge your retirement savings when most other accounts have contribution restrictions.
Just like any investment, time is your biggest ally with HSAs. The sooner you start contributing and investing, the greater your potential for tax-free growth. If you’re unsure about how HSAs fit into your overall retirement plan and how to prioritize different accounts, consider working with a financial planner. They can help you optimize your wealth-creation tools.