When you think of the different types of investing accounts you can take advantage of, you might think of accounts such as 401(k)s, Roth IRAs, Traditional IRAs, and brokerage accounts. One option available to many people is a health savings account, or HSA.
HSAs are relatively new, and are available to folks with high-deductible health plans, or HDHPs (they are plans with a minimum deductible of $1,300 if single, and $2,600 with family coverage). The first thing you should do is determine if you’re eligible to participate in an HSA. The second step is to determine if it’s worth participating in one.
The traditional advice I hear about HDHPs is that they’re great for healthy people because they rarely go to the doctor. In reality, they’re probably better for everyone the same way higher deductibles are usually worth it on home and car insurance policies. I say probably because every insurance plan is different.
For me, I was amazed when I looked at the price of traditional health insurance and compared it to a high deductible plan; there really wasn’t that much of a difference. Even after reaching my deductible one year due to some unexpected surgeries, I still came out ahead with more money in my pocket using the HDHP. My advice is not just to assume one plan is better or more expensive than another, and really read the documents your insurance company provides during open enrollment.
Now that you’ve determined if an HDHP is right for you, it’s time to add the icing to the cake. One benefit of an HDHP is that you can open up an HSA. Just like a 401(k), a lot of the benefit of an HSA is determined by how generous your company is. Your company may decide to fund part of your HSA, and may provide options for you to invest a certain part of your HSA, much like you do a 401(k).
So what exactly is an HSA? It has a lot in common with traditional retirement accounts, even though they’re related to healthcare. Most people use an HSA to save pre-tax money to be used to pay for future medical expenses. So while you might have a $1,300 deductible each year, if you are in the 25% tax bracket and pay for the first $1,300 in medical expenses using your HSA, you would only see $975 removed from your after-tax paycheck. You would actually see even less removed, because you’re not paying Social Security, Medicare, state, and local taxes either. Contributing to an HSA might be enough to lower your adjusted gross income to qualify for other tax breaks.
The most you can contribute to your HSA in 2015 (both personally and your employer) is $3,350 if you’re single, and $6,650 if you’re married, along with a $1,000 “catch up” if you’re over 55. In the 25% tax bracket that might reduce your take-home pay by $2,512.50 if you’re single, $4,987.50 if you’re married, and the catch up is another $750.
Unlike a flexible spending account (FSA), the money you put into an HSA is always yours. If you don’t use it, it rolls over for the next year, and if you no longer are eligible to contribute to an HSA, you still keep the account. So if you have an HDHP this year and contribute to an HSA, you can switch to a lower deductible plan next year and use whatever money you have in your HSA towards eligible expenses.
Since HSAs were intended to pay for healthcare expenses, you are penalized if you withdraw the money for any other purpose (a 20% penalty, plus income taxes). If you do use the money for healthcare related expenses, the money withdrawn is tax-free, so you’re basically getting a 25% discount on everything healthcare related you buy (or whatever your tax bracket is).
If you need the money from an HSA, there is also a cool benefit many people aren’t aware of. Say you start an HSA in 2015, and in 2016 you have a $15,000 medical bill. Since you could only have a maximum of ~$6,700 in your HSA if you are single, you would have to come up with the remaining $8,300. Since you put funds into your HSA before taxes, the first $6,700 only costs you $5,025. The benefit is that you can continue to take money out of your HSA in 2017, 2018, and 2019 to pay yourself back for the $8,300 you paid out-of-pocket, saving you another $2,075.
But I’m here to tell you to ignore all of that! Why? Because many HSA providers allow you to invest your HSA balance. If you can afford it, and your company’s plan offers good investment options, an HSA is an excellent retirement benefit. Like always, I’ll assume a 7% return on investment and a 25% income tax rate. If you’ve maxed out all of your taxed advantaged retirement accounts and were considering where to invest next, here’s where an HSA is a great choice.
If you invest $3,350 a year in an HSA, you would have $2,512.50 taken from your paycheck. That means you could invest $2,512.50 in a brokerage account or $3,350 in an HSA, and have the same amount in your paycheck each month. Over 20 years, you would have $146,948.34 in your HSA, and $110,211.26 in your brokerage account. Do it for 30 years, and you’ll have $338,594.69 vs. $253,946.02. The HSA will be even larger, since I didn’t factor in capital gains tax on the brokerage account (at 15% paid each year the numbers are 146,948.34 vs. $97,398.31 at 20 years, and $338,594.69 vs. $208,609.44 at 30 years).
If you have the funds, have an HSA plan that provides investing options with low fees, and have an HDHP, it really makes sense to save money in your HSA for retirement. It’s pretty easy to estimate most of the expenses you’ll have in retirement, except for healthcare costs. Most people also fear not enough money in case of an emergency, and health-related issues are probably the only real emergency we’ll face in our lives.
Treating an HSA as an investment account is like getting the tax-free contributions of a traditional IRA, the match of a 401(k), the tax-free growth of any IRA and 401(k), and the tax-free withdrawal of a Roth IRA. Win, win, win, and win!
At age 65, you can withdraw the money for any purpose, and only pay income tax on the amount you withdraw, similar to a 401(k). The withdraws are of course tax-free if you use the funds for healthcare expenses.
The younger you are, the better deal investing money in your HSA can be, since your money grows tax-free for a longer period of time. All of the numbers mentioned in this post will go up with inflation (maximum contribution, minimum and maximum deductible), so each year you may be able to contribute more.
So the next time open enrollment comes around, take a close look at the prices of the plans your company offers, and determine if investing money in an HSA is another way to save up money for a secure retirement.