Although most of us don’t have access to the fancy fringe benefits offered by some big tech companies, the majority of us do have access to something far more valuable – the Health Savings Account, or HSA. It may not be as flashy as a company car, but it will pay off in spades during your retirement years. That’s because it’s the only triple-tax-advantaged account available to U.S. workers (if you live in California or New Jersey, contributions and earnings are taxed by your state, but not the federal government). The key to this potentially lucrative retirement vehicle is understanding how to maximize its features and when – and when not – to use it.
You may not have considered an HSA because the only way to get one is to enroll in a high-deductible health insurance plan. This means you’ll have to pay at least the first $1,400 in medical bills if you’re single, or the first $2,800 in medical costs for a family, before your insurance provider will cover any health expenses. For many people, especially those with young families or ongoing health issues, an HMO (health maintenance organization) or low-deductible PPO (preferred-provider organization), is just a more affordable option.
That said, HSAs were specifically created and designed to help individuals and families afford these higher-deductible health plans. The idea is to make regular contributions to your HSA, and then, when medical costs arise, pull money from your account as a tax-efficient way to cover those expenses. Using an HSA in this manner, most people fund their accounts throughout the year and then pull that money out to cover medical costs as they come up. As a result, HSA funds are typically depleted or significantly lower by year-end.
While that’s the way most people use their HSAs, if you can afford it, there’s a much better approach. It works best if you’re healthy, with minimal medical costs, or you simply have the extra cash flow to cover your or your family’s health care expenses. Understanding the triple-tax-advantaged features of an HSA is also key: HSAs are funded with pre-tax dollars, funds inside the account grow tax-free, and any distributions – if used for qualified medical expenses – come out 100% tax-free. In effect, an HSA is the only account available to U.S. employees that avoids all tax whatsoever.
The key then is not to deplete the money inside your HSA each year for medical expenses, but to fully fund the account annually, and cover any health care costs with out-of-pocket dollars. Individuals can contribute up to $3,650 to their HSAs in 2022, while families can add up to $7,300. If you’re lucky, your employer may even pitch in towards those contributions. But even without an employer match, it’s worth regularly contributing to your HSA. That’s because most HSA providers allow you to invest any funds over $1,000 in an investment portfolio. In time, with regular contributions, tax-free growth on an HSA investment portfolio, and the power of compounding throughout your working years, your HSA account balance can grow substantially!
That’s important because health care is typically the largest expense in retirement. And funding your HSA regularly will go a long way towards bridging that gap. At the same time, striking a balance between our current expenses and retirement savings can lead to even better financial outcomes. I learned this the hard way.
In 2020, just before the COVID pandemic, I broke my leg skiing and needed surgery. Having already signed up for a high-deductible plan that year, my husband and I braced ourselves for some big medical bills. No problem, we had the cash flow to cover it and might even be able to take some tax deductions. Unfortunately, it was a bad break, and another surgery was required the following year. The real misfortune was that I knew ahead of time I’d have more medical costs in 2021 but my zeal for funding our HSA overrode common sense. I again signed up for a high-deductible health plan when, financially speaking, a low- or no-deductible health care plan would have been a much better choice.
The money my husband and I could have saved with a no-deductible health care plan could have been redirected into a taxable investment account for future growth. While that account type doesn’t have the triple-tax advantaged features of an HSA, it still would have meant more money in our pockets over the long run.
So please learn from my mistake, do a little math, and determine if a low- or no-deductible health care plan would result in significant cost savings for the year ahead. I’d also advise against rental skis that don’t easily detach from your boots while going down a hill that is too advanced for your over-confident self. But you already knew that.
Ideally, you’ll fund your HSA most of the time, and when medical circumstances dictate otherwise, you’ll pivot and choose the most economical health plan for your situation. The point is to fund your HSA as often as it makes financial sense; and fortunately, for most of us, that is most of the time. That’s good news because it’s estimated that the lifetime cost of medical care for a healthy 65-year-old is over $400,000*, and that doesn’t include long-term care. A health savings account can help cover those costs, and all the more so as distributions are 100% tax-free when used for qualified health expenses – including your Medicare premiums! So if and when your situation allows, consider funding an HSA and look forward to a healthy, tax-free medical savings fund in retirement!
* https://www.rbcwealthmanagement.com/en-us/insights/the-real-cost-of-health-care-in-retirement
EP Wealth Advisors, LLC (“EPWA”) makes no representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information presented in this report. EPWA has used its best efforts to verify the data included. The information presented was obtained from sources deemed to be reliable and deemed to be accurate as of the date of delivery. However, EPWA cannot guarantee the accuracy or completeness of the information offered. The content of this report is subject to change often and without notice.
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