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Learn why everyone loves
Raymond HSAs and why the best retirement account might not be a retirement account after all
How nice to meet you, HSA
The HSA, known formally as the Health Savings Account, is regarded within the finance community as the best retirement savings account, even though it is not one! Created by Congress to help the average Joe pay for medical expenses, it packs a secret one, two, three punch.
After writing my last post on the once-per-lifetime IRA to HSA Rollover, I decided a dedicated post on the Health Savings Account was overdue. While I have highlighted the basics of the HSA before in the ABCs of Retirement Investment Accounts, this unique account deserves more love, as everyone loves
Raymond, I mean HSAs.
Why the HSA is a black belt in retirement savings
On the premise, the HSA is a simple account. Money comes out of your paycheck before federal and state taxes and is deposited to the account when you work for a company that sponsors one. If not, you contribute to your HSA and receive a tax return deduction to offset any federal and state taxes. Then, once you have medical bills needing to be paid, you withdraw money tax-free and pay them off. Thus, the HSA helps stretch the purchasing power of your dollars.
Here is where things get interesting, though. When the HSA was created, the legislation parented a martial arts master hiding in plain clothes. Not only can money go into an HSA before taxes, then being withdrawn for medical expenses without them, but the funds can also be invested and grow tax-free when in the account.
This means that you can deposit, grow, and withdraw funds from your HSA without ever incurring taxes. If this wasn’t sweet enough, FICA and Medicare taxes are not withheld when contributions are made directly to an HSA from one’s paycheck. These HSA holders that their employer sponsors save an instant 7.5% on taxes; no other account can boast this feat.
The combination of the above features: Deposits, growth, and withdraws, all tax-free, has earned the HSA the designation as the triple-tax-advantaged account. In addition to these great features, for those that manage to make it to retirement with no medical expenses, the HSA can be drawn from without penalty, being treated similarly to an IRA when used for non-medical expenses.
So, if the HSA is so great, why doesn’t everyone have one?
Ah, the fine print. Well, to contribute to an HSA, the IRS requires you to have a High Deductible Health Plan (HDHP). What in the world is a HDHP, you ask? It is a health insurance plan that meets the requirements of having a high out-of-pocket deductible, meaning that before your insurance pays out a penny, you must pay a substantial chunk of change first.
Now, for many people who buy health insurance on the public exchanges, HDHP’s are commonplace. Among those who work for an employer that offers insurance, HDHPs are not as common. Increasingly, though, these plans are becoming more prominent in the workplace as companies look to save on costs.
Rather than trying to determine if your health insurance plan qualifies as a HDHP, call your insurance provider and ask them directly; this alleviates any confusion and mix-ups regarding eligibility.
How much can I contribute?
So, now that we know you can contribute to an HSA, the question is not whether you should, but rather how much can you contribute?
As I previously covered in The Ultimate Savings Hierarchy, the HSA is the first account people should maximize, once they take advantage of any company match and pay off all high-interest debts. For HSAs, the limit that individuals can save varies based on several factors as of writing this post in 2021.
If your HDHP covers only yourself, you can contribute up to $3,600; those covering their family with an HDHP are allowed $7,200.
Once you are 55 or older, you can contribute another $1,000 to your HSA. If your HDHP covers your spouse, and they are 55+, they are entitled to make a $1,000 contribution as well, but they must open a separate HSA under their name to do this. I know that is a strange requirement since your HSA covers the family, but the IRS mandates this.
Thus, as of 2021, the maximum amount that a family covered by a HDHP can contribute towards HSAs is $9,200, if they have two members that are 55+. I suggest funding your HSA to the maximum amount allotted to you, assuming the financial means are present.
If you do not have the funds available to contribute to your HSA but have a pressing medical expense, I encourage you to consider the once-per-lifetime IRA to HSA rollover. While not the best choice for those who have the means to maximize their HSA through regular contributions, it is a lifesaver for those faced with medical bills and nowhere else to go.
The reason why I only implore those who are financially stressed to use the rollover method is twofold. First, it counts towards that year’s contribution limit. Second, it is only allowed once per lifetime, so it should only be used in strategic or dire situations.
But what happens to my HSA if I don’t have medical expenses?
As I briefly mentioned above, the HSA has the benefit of protecting those who overfund it. Suppose you manage to retire in excellent health and have no medical expenses. In that case, you can treat your HSA as a traditional IRA account, meaning you draw from it for whatever reason and only pay income taxes on those amounts. If they happen to be related to medical needs, then you pay no taxes. Additionally, for those with long-term care expenses in retirement, HSAs can be used towards these burdens tax-free!
What happens to my HSA if I stop carrying a HDHP?
You get to keep it and spend it whenever! Say you have a HDHP in 2021 and fund your HSA, but no medical expenses occur. Come 2022, you switch over to non-HDHP insurance but have medical bills that year; great news, your HSA funds from the prior year can be used.
HSA benefits do not expire or go away, save your HSA for a rainy day!
What if I can cover my deductible without using my HSA?
So, you happen to be lucky or diligent enough that you can both separately fund your HSA and cover your deductible each year. In that case, you can invest your HSA and let it grow tax-free well into the future. Just hold onto your receipts for any out-of-pocket medical expenses incurred in the present. When you are ready to use the funds in the future, you can reimburse yourself tax-free without penalty.
English translation: If you cover your deductible and don’t use your HSA for the costs, you can reimburse yourself from your HSA later. All you need is to include the prior receipts with your tax return during the year the withdrawal occurs, demonstrating that the need is medical-related. If you are unsure how to do this, talk to an accountant!
Thus, those who have the means can use their HSA to create a stream of future income tax-free. For those looking to FIRE or achieve financial security, the HSA is a no-brainer; you receive the benefits of tax write-offs, compound interest, tax-free growth, and tax-free withdrawals.
What happens if I withdraw from my HSA before 65 and it is not for health reasons?
Well, you shouldn’t, but life happens. If this is the case, you will owe income taxes on the withdraw and pay an additional 20% penalty. If you happen to be reimbursing yourself for previous out-of-pocket costs outlined in the section above, the taxes and penalties do not apply.
When is the last day to contribute to my HSA?
As of 2021, HSA contributions can be made from January 1st of a given year through April 15th of the following year, similar to IRA accounts. This means if you have not contributed to your HSA for the prior year and it is before the April 15th deadline, you can still contribute.
What happens to my HSA when I die?
Nobody lives forever, and alas, your HSA cannot either. If your spouse is your HSA beneficiary, they will receive the HSA upon your passing. Their newly inherited HSA will be treated as if it had always been their own, meaning they are entitled to the same tax benefits. However, suppose you pass the account onto a non-spousal beneficiary (i.e., your kids). In that case, the account becomes taxable income at the time of your passing at the fair market value. If the account is passed onto your estate, then it is considered taxable income of the amount it was valued at your death.
In summary, everyone loves the HSA
As you can see, the HSA is the best retirement savings account, even if it is not technically a retirement account. Through the power of saving 7.5% on FICA and Medicare taxes, allowing contributions before income taxes, allowing investments to grow tax-free, and giving withdraws tax-free status for medical expenses, the HSA is like no other. Coupling these primary reasons with the fact that HSAs can be used for non-medical expenses once 65, the HSA should be on everyone’s radar.
If you use an HSA, I would love to hear if you use it for current medical expenses or if you plan to reimburse yourself in the future. For those that are new to the HSA, what do you think? Will you use it now that you know all the benefits?
I look forward to your replies and as always, have a great day!
Important note for those in California and New Jersey
Notably, if you live in CA or NJ as of 2021, both states do not conform to the federal HSA legislation. This means that you will not receive an income tax deduction and that gains are taxed in the year realized, but only on the state level. Rest assured that you will receive all federal tax benefits but that your state treats the HSA as an after-tax brokerage account. So, contact your local legislators and tell them you want this to change! To learn more about the details for CA and NJ residents, use this great article as a guide.
Mile High Finance Guy
finance demystified, one mountain at a time