What Is A HSA?
But first, for those of you guys who might be hearing about HSA for the first time. Or if you’ve heard of it before, but don’t know specifically what it is, let me explain.
It’s no news that medical costs have skyrocketed. Costs of medicine, procedures, and even doctor visits have increased faster than the rate of inflation.
In order to mitigate some of the financial risks, insurance companies have started offering high-deductible plans to many of its clients. With a high deductible plan, the insurance company provides coverage against catastrophic illness and injury at a more affordable rate.
In exchange, the insured is responsible for paying the first medical bills out of pocket each year; ranging from $7,000 for an individual to $14,000 for a family.
In order to help individuals and families handle these out of pocket costs, the HSAs, Health Savings Accounts were created.
A simple way to think about HSA is that it’s basically an IRA for your medical bills. However, as I’ll cover later in the article, the way it’s structured creates some great opportunities for an investor like yourself.
At the time of this article, 2022, you can contribute up to the following:
- $3,650 for Self-Only Coverage
- $7,300 for Family Coverage
If you are 55 and older, you can contribute an additional $1,000 each year through age 65 or until you enroll in Medicare. This is called a catch-up contribution.
But, make sure to check healthcare.gov for the latest updates.
Caveat - HSA is Not FSA
One thing to note before I get into all the benefits of an HSA is that, oftentimes HSA are confused with FSAs. Flexible Spending Accounts. They are not the same. If you don’t spend all the money with a FSA within a specific year, your account fund is forfeited. I know because I had this happen to me recently and it wasn’t a pleasant experience.
However, with a HSA. The money within the account and anything it earns, remains yours until you use it.
This Is Where It Gets Awesome
Now that we’ve covered what a HSA is, let me show you why this is the ultimate investment account.
The few benefits of putting your money in a tax advantaged account is the tax savings you get.
With a traditional 401K or an IRA, you don’t get taxed on your contribution. You are able to lower your taxable income by contributing your money into one of these accounts. Of course you still need to pay taxes when you pull your money out, but that initial pre-tax contribution is pretty awesome because it allows you to put more money into the account.
Then you have the Roth IRA or Roth 401Ks. From a tax perspective, it works on the reverse compared to a traditional 401K or a traditional IRA. Your contributions are taxed, however you don’t have to pay any taxes on your withdrawal.
This is where the HSA gets pretty awesome. The HSA can take advantage of both tax treatments.
Like a traditional IRA, you can fund this account with pre-tax money. And like a Roth IRA, you can withdraw your money tax free. You get the best of both worlds!
I know what you are thinking. Ok, Tae. That’s great news for my kids orthodontist expenses but what does this have to do with investing? And why are you calling it the ultimate investment account?
Great question. Let me answer that for you.
Isn’t HSA For Medical Expenses?
You are actually not required to pay your medical bills with your HSA. Even if you have a medical expense, you don’t need to tap into your HSA if you don’t want to. You can just pay out of pocket.
And this is great, because if you have your HSA fund in an appreciating investment, like a good low cost index fund, you can let it continue to grow like your regular retirement accounts.
And let’s say you do want to tap into this account. As long as you save your medical receipts, you can withdraw money from your HSA, tax and penalty free anytime. And this can be many many years later.
So what you have here is the ultimate legal tax sheltered account that if you ever need the money for medical expenses, it will always be there. However, even if you don’t, it would grow like any of your other investment accounts, tax-free.
And if we wanted to pull any money from it, we can just use some of the medical receipts we saved in the past and reimburse ourselves tax free from the HSA account.
If we are fortunate enough to remain healthy until we turn 65 without tapping into the HSA, then the HSA will be identical to a Traditional IRA for non-medical expenses. We can begin withdrawing money from it for any expenses after we turn 65 without penalty. We would only be paying taxes.
Alright, now that you are onboard with me to why the HSA is such an awesome investment vehicle, couple practical action steps to maximize its function:
So, What Should You Do To Maximize HSA?
- One, if you have a High Deductible Health Plan (HDHP), open a HSA account.
- Two, max out your contribution. This will help in lowering your taxable income. As I stated earlier, the contribution limit for 2022 is $3,650 for individuals and $7,300 for families.
- Three. And this is a key step. Invest the HSA. Don’t keep it in a savings account because inflation will completely destroy its value in the long run. Treat it like a retirement account and invest the balance in a low-cost index fund.
- Four. Don’t use your HSA to pay for medical bills. You want to allow the money in your HSA to grow. Unless it is a major expense, try to pay for all your medical bills from your regular checking account.
- Five. Hold onto all your medical receipts. More receipts you have, the more you can withdraw tax free down the line. Make sure to keep them in a safe place. I’d recommend scanning and uploading them all to the cloud for safe keeping and maintaining an itemized list.
- And six. Once you hit age 65, treat your HSA as a Traditional IRA. Assuming you turned 65 and you don’t have enough medical receipts to fully withdraw your account, you can use the HSA for ordinary expenses in the same way that a Traditional IRA can be used.
There you have it guys. I hope you I was able to help you understand why HSA is such a powerful investment vehicle and what are some next steps if you have a High Deductible Health Plan,
The bottom line is that anyone who has a high deductible insurance plan should definitely fund an HSA. The IRA wants you to use it and if you don’t like paying taxes, this is a great way to get around it, completely legal.
If you want to learn more about HSA, I recommend checking out a pretty amazing article that Brandon, the Mad Fientist wrote on his website. He is seriously one of the smartest guys I know in this personal finance / early retirement space and you won’t be disappointed.