Health Savings Accounts (HSA) are amazing, possibly the best financial vehicles for building wealth. In this article we explain why you should maximize your contributions to an HSA and pay for most, if not all, of your medical expenses out of pocket. We also compare an HSA to the more widely available Flexible Spending Account (FSA), which, unlike the HSA, if you don\u2019t use the contributions for each year, your money is forfeited.<\/em><\/p>\n\n\n\n

Health Savings Accounts (HSAs) have been around a while. WJL wrote an article over four years ago about them<\/a>, but I still get quite a few questions about these amazing financial vehicles. I think that is for two reasons main reasons. First, not everyone has access to an HSA. You can set up an HSA only if your employer offers a high deductible health insurance plan. If you have a high deductible plan option available, we get to the second reason, the very name of the plan: high deductible<\/em><\/strong> health care plan. High <\/em>and deductible <\/em>are not words people like to hear together in one sentence, and this scares people off before they learn more. In this case they should. At this point we should note that a high deductible plan is defined as having a deductible of at least $1,400 for an individual or $2,800 for a family.<\/p>\n\n\n\n

Most people are aware that HSAs, like the more widely available Flexible Spending Accounts (FSAs) many people have, are used to pay for medical expenses. Both types of accounts are funded with pretax contributions that can then be used to pay for after-tax medical expenses.  Tax savings are why both accounts exist, but you can only have one of the two. What separates them, however, is that FSA contributions must be used in the current period (usually April 15th after the calendar year the contributions are for) or the amount is forfeited. Forfeited funds within an FSA go back to your employer, who can split the funds among all employees in the plan or use them to offset the costs of administering benefits. You can guess where they are often used. <\/p>\n\n\n\n

Contributions to an HSA, however, are not forfeited at the end of the current period. Instead, contributions of up to $3,600 for an individual in 2021 ($7,200 for family) can be invested and used later, possibly many, many years later. The HSA custodian has the authority to decide which funds are offered within the HSA, but much like 401Ks, these fund options continue to get better and better with more options and lower fees. This means not only are contributions tax free, but so too are any gains earned within the account. Adding to all this sweetness is that many employers will contribute some funds to the account on your behalf. This employer contribution counts towards the maximum amount allowed to contribute.<\/p>\n\n\n\n

Like a traditional IRA or 401K contribution, contributions to an HSA are not taxed in the year made, but unlike IRAs or 401Ks, withdrawals from HSAs are not taxed if used for qualified medical expenses. As most people understand, our health is likely to decline as we age and in America medical expenses are about as certain as death and taxes. This almost ensures that contributions to HSAs will not be taxed going in or coming out, making them completely tax free. I\u2019m not aware of any other account that provides this benefit. <\/p>\n\n\n\n

Even if you are a medical miracle who never gets sick or incurs any medical costs, you can still withdraw the money after age 65 for any reason without penalty. In this case you would pay income taxes on the withdrawal, as you would with a traditional 401K or IRA withdrawal, but there is no penalty. This is a good option to have, but I doubt it is often used. Fidelity did a study<\/a> that estimated the average out of pocket medical expenses after age 65 is $295,000 in after-tax dollars.\u00a0<\/p>\n\n\n\n

Example: Growing Wealth with an HSA<\/strong><\/p>\n\n\n\n

Like most things in finance, the HSA is most powerful for young investors with a long-term horizon, but even more with HSAs because the investor is also probably healthier with lower actual health care costs than a similar but older investor. For example, Addy who is 24 years old, invests the maximum amount in her HSA ($3,600\/year inflation adjusted) until she is 35 and then stops. Assuming a rate of return of 7%, her balance in the HSA will grow to $385,503 by the time she is 60. She will then have this money to pay for medical bills with no income implications.<\/p>\n\n\n\n

If Addy invested the same amount in a 401K, it would also be pretax, lowering her current year tax burden, and also be worth the same amount at age 60: $385,503. There would be some negatives, though. The first is the tax impact. If money was withdrawn from her 401K, it would be taxed. Assuming a 24% tax bracket, the amount saved would only pay for expenses of $292,222; over $92K was lost to taxes! But it is worse: as the money was taken out of her 401K, it increased her taxable reported income too. This could impact her eligibility for other tax breaks or programs. <\/p>\n\n\n\n

Now let’s think about 60-year-old Addy. She may have retired early since she made so many good financial decisions when she was young and is probably receiving her health insurance from a state exchange for the gap period between stopping work and being eligible for Medicare. Every dollar she takes from the 401K increases her reported income and could reduce her premium subsidy, making insurance cost more. Even once she turns 65 and is eligible for Medicare, the withdrawals from her 401K could impact her standard Part B premiums too.<\/p>\n\n\n\n

The logic and math are the same for older investors as well, but there are fewer periods of compounding, so the numbers are smaller. There is however a catchup provision, like other retirement accounts, allowing investors over 55 years old to put an additional $1,000 in the account. A 55-year-old putting the max amount in for the 10 years before retirement can certainly still stash away quite a large amount.<\/p>\n\n\n\n

Dealing with Current Medical Bills<\/strong><\/p>\n\n\n\n

But what about all my medical bills now? I\u2019m used to being reimbursed for these from my FSA!<\/em><\/p>\n\n\n\n

It\u2019s a lot easier for a 24-year-old with few if any medical bills, but the best option is to pay any medical bills out of pocket. In a perfect world, the world congress envisioned when they set up these plans, paying out of pocket would incentivize you to take care of your health proactively by eating better, exercising more, engaging in less dangerous activities, and questioning the necessity of medical procedures before blindly accepting a doctor’s recommendation. The theory is if you have more skin in the game you will manage expenses better.<\/p>\n\n\n\n

Paying out of pocket has the additional benefits of decreasing your disposable income, hopefully curtailing other unneeded expenses, which can also help financially.<\/p>\n\n\n\n

But this is the real world where people enjoy alcohol-rich IPAs and skiing through trees\u2014sometimes in that order. So one compromise to the full out-of-pocket option is to only submit bills for reimbursement through the HSA if they are over a certain threshold based on your own personal budget, say $500, and to pay for the rest out of pocket. This would lower the total saved but would still boost your savings. <\/p>\n\n\n\n

Risk: Accessibility of Funds<\/strong><\/p>\n\n\n\n

There are not many risks to an HSA. One could be that many employer-sponsored plans force you to use the bank they have negotiated with, which may only offer high(er)-fee mutual fund options. As mentioned earlier though, options continue to get better as investors become more educated and put pressure on their companies. You can also roll over the HSA to a firm that offers low-cost mutual funds after<\/strong> you leave the company. Those signing up for a high-deductible health care plan on the individual or state market exchanges have a lot more flexibility.<\/p>\n\n\n\n

The biggest risk to an HSA is the HSA’s strongest benefit: its flexibility. A lot of the withdrawal hurdles created for retirement plans such as 401K and IRAs were put into place to protect investors from themselves. Impulses to withdraw the funds due to an immediate need at the expense of retirement is the surest way to derail an otherwise excellent plan. Because HSAs allow withdrawals at any time without penalty (assuming the investor has kept medical expense records), the temptation to pull funds out may prove too great.<\/p>\n\n\n\n

Value of the HSA as Retirement Vehicle<\/strong><\/p>\n\n\n\n

Health Savings Accounts (HSA) are amazing wealth-building vehicles that should be considered by every investor who has access to one, especially younger investors, possibly before maxing out other retirement vehicles. Their ability to help manage cash flow in both a traditional retirement and early retirement makes them invaluable.<\/p>\n\n\n\n

Until next time, spend less than you make, invest the difference in low-cost index funds, be kind to your neighbors, and you will succeed in reaching your financial goals and in making the world around you a happier place.<\/p>\n\n\n\n

If you feel you could use some assistance along the way, please feel free to reach out to us<\/a>.<\/p>\n","protected":false},"excerpt":{"rendered":"

Health Savings Accounts (HSA) are amazing, possibly the best financial vehicles for building wealth. In this article we explain why you should maximize your contributions to an HSA and pay for most, if not all, of your medical expenses out of pocket. We also compare an HSA to the more widely available Flexible Spending Account […]<\/p>\n","protected":false},"author":4,"featured_media":1329,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":""},"categories":[17,12,16],"tags":[39,37,38,5],"class_list":["post-1327","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-insurance","category-investing","category-retirement","tag-healthcare","tag-hsa","tag-investing","tag-retirement"],"yoast_head":"\n