Health Savings Accounts – The investment account that nobody wants to use
The financial world and financial planning are filled with a lot of unknowns. When developing a strategy for long term savings there are variables in which we have no control. But the key to success is to maximize the benefit of the variables you can control.
When it comes to account selection for your savings tax, benefits should be the number one factor to consider. The second factor is the availability of specific accounts based on your financial status. The more money you are able to save in taxes long term, the more resources you will have for future goals. Your net worth via tax savings will dwarf other financial variables, like subpar investment choices. And since we cannot control returns, let’s control taxes!
Health Savings Accounts are the masters of tax savings. In my opinion, they are among the best investment vehicles that can be used for tax savings. The caveat is that you are only eligible if you participate in a high deductible health insurance plan. That requirement, frankly, is a low bar, but makes the initial image of an HSA unappetizing. In order to qualify for the account, you have to use a medical plan with a lower amount of coverage. Who wants that?
Who should want a Health Savings Account? And why?
To simplify who should want an HSA; if you do not anticipate having a lot of medical expenses on an annual basis, then a high deductible plan and an HSA may have substantial long-term benefits. Albeit, researching your plan is key to determine the best plan at your disposal.
For those who qualify for an HSA, opening one is a must, and contributing is just as important. Studies have shown that very few people maximize their benefits (JAMA Network), either by not opening an account and/or not funding one that is open. Even if you do not have access to an account directly through your medical plan, you can open an account on your own through your bank or the many brokerage firms who offer the service.
Here’s what people are missing: With an HSA, you can contribute an aggregate amount up to $3,600 per year as an individual or $7,200 as a family, with an additional $1,000 ‘catch-up’ if you are over 55 (2021 IRS allowable amount) and the contribution deadline is the annual tax deadline. The first benefit of the account is that these contributions reduce your taxable income dollar for dollar! They save you taxes in the year of your contribution.
Here’s another thing people are missing: Your HSA accounts is just like any other brokerage account. Not only does the account not follow ‘use it or lose it’ rules (you can let your balance accumulate) you can also invest the account in whatever investments the custodian allows, letting your money to grow over time. And your gains are tax free! So not only do you save money during the year of the contribution, but you are also saving money on capital gains as the account grows.
And there is a final benefit people are missing; when you are ready, you can take some or all of you your balance at any time for qualified health related expenses. And I mean ‘any time’. If you have a medical expense this year, and you have an already established HSA at the time of the expense, you can save all relevant receipts and offset HSA distributions this year, next year or 20 years from now…..whenever you want. And those distributions are also tax free!! An HSA is a triple tax-free account.
The Health Savings Account strategy
The basic strategy for an HSA is to contribute and invest. Again, it’s important to consider how much you will need for medical expenses each year and determine if a low deductible plan would be better. If you think your expenses will be low, open an HSA and put in the maximum contribution each year. Resist the urge to use the account for the small expenses (copays, prescriptions, etc.). Give your money time to grow.
Save your receipts! Develop a sound system for tracking expenses and be very thorough. The IRS will want to see a paper trail of the expenses you report if you ever go through an audit. And they don’t accept ‘oops’ as an answer. Penalties can be steep.
Let your investments grow over time and use the account as a method to get tax free money later in life (preferably in retirement). A single person opening an IRA at 30, and max funding each year, has an opportunity to save over $400,000 of HSA funds by retirement. Again, tax free!
One final note: once you turn 65, the funds can be withdrawn without penalty for any reason, although the withdrawals will be taxed similar to IRA distributions (so it’s always best to use the funds for qualified medical expenses whenever possible).
If you can, open and save into an HSA if it makes sense for your situation. The fact that this investment vehicle is so underutilized in this country makes my inner planner weep.
Blog posts are the opinions of Owl & Ore planners and staff. They are not intended to be financial advice. Please consult a financial planner or tax professional for advice relevant to your specific situation.