A health savings account or an HSA for short, is the best tool for investing that none of us are using. But why is that?
Most of us understand our 401ks, and realize we at least are suppose to contribute up to our employer match. And if you aren’t doing that, stop what you are doing, and immediately make that change. Because you are leaving free money on the table, and we like free money.
Anyways…
Most of us even have some understanding of IRA accounts. Maybe we don’t understand whether a traditional or Roth IRA is better given our own situation, but we at least understand we should be investing in one. (I plan to discuss this concept in future blog posts)
Each of these are great vehicles to invest with but both require us to either pay taxes on the front end or the back end. Meaning paying taxes on our money before we invest it or paying taxes when we withdraw our money from the investment vehicle.
What if I told you, that you wouldn’t have to pay taxes at all?
So What is an HSA?
An HSA or Health Savings Account is a tax-advantaged investment tool used to save for medical expenses for those of us with high-deductible health insurance plans. It’s the governments way of incentivizing us to save for potential healthcare costs because most people with high deductible plans normally have high out-of-pocket costs and are often ill-prepared to pay them.
An HSA offers equivalent investment options to that of a 401k depending on which company you get your HSA through. So per usual, I invest every dollar of my HSA account in low cost index funds just as I do with all of my other investment vehicles. Just because it’s simple, doesn’t mean it isn’t smart.
So Who Qualifies for an HSA?
As mentioned, only people with high deductible insurance plans are eligible for an HSA which in 2019 is defined as a deductible being above $1,350 for individuals and $2,700 for families.
Secondly, your health insurance plan also has to have an out-of-pocket maximum threshold of less than $6,750 for individuals and $13,500 for families. Below is a chart for quick reference to determine if you qualify. These days most of us qualify for an HSA but few of us actually take advantage.
How Much Can I Invest in an HSA?
The HSA contributions are adjusted annually, but in 2019, the IRS allows individuals to invest $3,500 per year and families to invest $7,000 per year. If over the age of 55, the IRS does allow a catch-up contribution of an extra $1,000 for each category.
Just like most investment vehicles, HSA contributions can be made up until the April tax deadline
What Makes an HSA so special?
An HSA is so special due to the tax advantages these accounts offer because as mentioned, the government is try to incentivize us to use them.
1) Tax Free Contributions. Example) If you made $50,000 in 2018, and contributed $3,000 to an HSA, your taxable income would be $47,000 where thereby decreases your tax liability.
2) Tax Free Growth. The money invested in an HSA is allowed to grow annually without any taxation on money earned (I.e. No tax on capital gains, interest income, or dividends)
3) Tax Free Withdrawals. Any money withdrawn to pay for eligible medical expenses can be withdrawn tax free.
Basically, you will never have to pay taxes on any money invested into an HSA. Sweet, right?
| Investment Vehicle | Tax-Free Contributions | Tax-Free Growth | Tax-Free Withdrawal |
| 401(k) | Yes | Yes | No |
| 403(b) | Yes | Yes | No |
| Traditional IRA | Yes | Yes | No |
| Roth IRA | No | Yes | Yes |
| Roth 401(k) | No | Yes | Yes |
| HSA | YES | YES | YES |
So What is eligible for HSA Withdrawals?
So like I mentioned above, when withdrawing money from an HSA account tax free, it has to be withdrawn for eligible medical expenses. So what qualifies?
For the most part, most things are covered, but here is a list of some of the most commonly asked about.
- Surgery
- Doctor’s Visits
- Therapy
- Dental Care
- Prescription Drugs
- Psychiatric Care
- Eye Care
- Medical Equipment
- Long-Term Care
- Elective Surgeries such as lasik or breast augmentation
- Chiropractic Services
- Home Care
For the complete list of qualified medical expenses, you can check out Publication 502 because even things such as lodging, food, and transportation can be covered if related to a medical expense.
Do I Have to Withdraw from my HSA Account When I Have Qualifying Medical Expenses?
No, and I suggest never withdrawing from your HSA account with any qualifying medical expenses, until you plan to use that money for retirement.
There is no rule that states you can’t delay your withdrawals from your HSA with qualifying medical expenses. Meaning, that as long as you save your medical receipts, you can withdraw the money from your HSA at any point.
So pay for your medical expenses out-of-pocket, keep your receipts, and allow your investments to continue to grow tax free. Then, once you are entering your early retirement years, you can use the past medical bills to withdraw from your HSA tax free.
What Happens if I don’t have any medical expenses?
First of all, if this happens, congratulations! Lets not look at this as a bad thing, if your medical costs are that low, you are likely winning in general due to the money saved on medical expenses.
In 2017, according to the CMS, the average person in America spent $10,739 per year in healthcare expenses. This same study also reported that out-of-pocket spending rose 2.6% up to $365.5 billion from 2016 to 2017 as people continue to switch to high deductible healthcare plans.
The moral of this narrative, is that it pays to be healthy.
Moving forward, so you’re healthy, you have minimal medical bills, so what happens to this accumulated money since you can’t withdraw it for health expenses?
An HSA account then simply works like a traditional IRA account with a later withdrawal age, 65 (instead of 59.5). So basically, at age 65 you will be able to withdraw your money saved in your HSA for ANY expenses. You will only pay income taxes on the withdrawn money without penalty, just like you would with a traditional IRA.
Bonus: An HSA also has no minimum require distributions at age 70.5 like other investment vehicles such as a traditional IRA. Meaning, you aren’t required to start withdrawing from your HSA just because you reach a certain age. You can keep letting your money grow tax-free if you choose.
What if I withdraw the money early without a qualified medical expense?
If you are under 65 and you withdraw money from your HSA without a qualifying medical expense, you are subject to a 20% withdrawal fee plus income tax. So at all costs, avoid this if possible.
How I Recommend Using an HSA
The way I have learned to use my HSA is obviously specific to my circumstances, but what I have found and read, is that this strategy allows me to save and grow the most money. So let’s break it down, step by step.
- Live a Healthy Lifestyle: Although it’s obvious, if we minimize our need to spend on healthcare, we maximize the money we keep in our pocket. It also minimizes the possible need to withdraw from our HSA allowing this invested money to grow.
- Contribute the Annual Max to your HSA: This decreases your taxable income and could potentially save you thousands in taxes.
- Max Out Your HSA via Payroll Deductions: By contributing to your HSA directly from your payroll, your money is not subject FICA which is the federal income tax that goes towards Social Security and Medicare. This saves an additional 7.65% in taxes.
- Invest Your Contributions in Low-Cost Index Funds: Why do invest in anything different? As we have shown, it’s the simplest and safest way to maximize your portfolio growth.
- Allow Your HSA to Grow: Don’t withdraw from your HSA account even when you have qualifying medical expenses. Pay for your medical expenses out-of-pocket and then save your medical receipts. Allow your contributions to continue to grow tax free. Remember the power compound interest can have?
- At Age 65+, Withdraw like a Traditional IRA: With any money left over in your HSA that you you can’t withdraw using qualified medical expenses, you are able to withdraw the remaining balance for ANY expense. Just like you would a traditional IRA, you are only responsible for paying income tax.
Where to Get an HSA
Some work places offer their own HSA, and some are even beginning to contribute a percentage to these accounts. However, you have to make sure you verify this is in fact an HSA and not an Flexible Spending Account or FSA. As an FSA is a very poor investment tool for early retirees as these accounts require most of the money invested to be used with an the year.
For those of us who’s companies don’t offer an HSA, I recommend anywhere that offers the best low-cost index funds. For me, that’s Fidelity as they have some of the lowest expense ratios offered to date.
Conclusion
An HSA is an extremely powerful investment tool when used correctly, especially for the early retiree. It offers a triple-threat of tax advantages with tax-free contributions, tax-free growth, and tax-free withdrawals.
It’s an amazing tool, but a tool that few people are taking full advantage of, likely because they don’t know the rules. Early retirement in general is all about knowing the rules better than everyone else, and taking advantage in spots where others aren’t. Hopefully, this can help shed some light on the topic and possibly inspire you to open your own HSA account.
Are you utilizing an HSA? Or do you have a different favorite investment tool?
If you have any specific questions about health savings accounts, feel free to comment below or contact me here.
