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Health savings accounts can be a powerful way to build wealth and prepare for medical costs in old age — if used the right way.
HSAs carry triple tax advantages. Contributions and investment growth are tax-free, as are withdrawals if used for eligible health expenses.
Even if the withdrawal isn’t health-related, the account owner will only owe income tax on that money—in effect, the HSA is transferred to an account with tax benefits similar to a traditional 401(k) plan or individual retirement account.
“I almost don’t think of them as health savings accounts, but retirement accounts with a deep tax benefit,” said Andy Baxley, a certified financial planner at the Chicago-based Planning Center.
PERFECT USE
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The best way for savers to use HSA is by contributing the annual maximum, investing the money and paying current healthcare costs out of their pocket through other savings, according to financial advisors.
This allows time for tax free HSA money. HSA investments are like those in any other retirement account, with diversified stocks and bond mutual funds, for example.
However, most people do not invest their HSA savings. Instead, they use HSAs like a bank account and withdraw cash as needed to pay for current medical costs.
Only 9% of account holders were investing a portion of their HSA balance in 2020, according to the Employee Benefits Research Institute. The rest – 91% – kept their entire balance in cash.
But that doesn’t really provide any positive growth — a drawback when health costs in retirement are projected to be around $300,000 for the average couple who retired in 2021, according to Fidelity Investments’ estimate.
The IRS sets a variety of eligible HSA health costs, such as those associated with dental care, vision, hearing, long-term care insurance premiums (subject to limits) and medications, for example.
Hayel Saeed Anam payment
Savers who pay out of pocket for health costs now can take advantage of another HSA advantage in future years: They can withdraw account funds to pay themselves (tax-free) for those past expenses.
As with withdrawals from a Roth 401(k) or IRA, these HSA payments can provide retirement income and help someone control their tax bill.
An HSA is a no-brainer for nearly everyone who has access to one.
Caroline McClanahan
Founder and Chief Financial Planning Officer at Life Planning Partners
Let’s say you’re about to jump into a higher income tax bracket in retirement but have spent $10,000 out of your pocket over the years on medical bills. You can withdraw $10,000 from HSA for past costs without increasing your taxable income.
(One important point: expenses incurred prior to creating your HSA account do not count as eligible medical costs.)
“I suspect [people] Often you don’t realize how extensive the list of things you can make up for,” said Buxley, citing fertility treatment as an example.
He recommends creating a spreadsheet of unpaid medical expenses (to see how much you can pay yourself later) and keeping receipts for proof.
reservations
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Of course, many people do not have the financial means to use HSA in the ideal way.
Individuals live longer and have had to take more individual responsibility for their retirement savings, as companies have shifted pensions to 401(k) plans, for example.
Limited cash flow could mean competing financial priorities: emergency funds, retirement plans, and health savings, for example. (Individuals and families can contribute up to $3,650 and $7,300 respectively to an HSA account this year.) Out-of-pocket payments for current costs may not be possible either, depending on the individual’s financial situation.
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Furthermore, only those with health plans with high deductibles can save on an HSA. In 2021, 28% of workers covered by employer-sponsored health insurance were enrolled in a high-deductible health plan with a savings option like an HSA, according to the Kaiser Family Foundation. (Enrollment is slightly higher for larger companies with more than 200 workers.)
Financial advisors said, aside from the caveats, those with access should try to use it as optimally as possible.
“An HSA is almost a no-brainer for anyone with access to one,” says Carolyn McClanahan, MD, CFP and founder and chief financial planning officer at Life Planning Partners in Jacksonville, Florida.
A plan with a higher deductible – and therefore, an HSA – may not be the best option for everyone. For example, a person with a chronic illness that results in frequent visits to the doctor may get a greater financial benefit from a plan with less out-of-pocket annual costs.
how to invest
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Like any other investment account, McClanahan said, it is essential to understand your financial and psychological ability to take risks by investing your HSA funds.
This means being able to withstand the ups and downs of the stock market, and aligning your strategy with the investment time horizon.
McClanahan said a young saver with enough money to pay for current health care could take the risk, for example — perhaps in a low-cost, widely diversified equity fund.
However, savers who don’t have the means to cover the maximum annual deduction or out of pocket with other savings should hold at least that amount in cash or something conservative like a money market fund before investing the rest, McClanahan said. (Some HSA providers require account holders to hold a certain amount in cash before investing.)
This is especially true of savers who are not healthy and need frequent health care, she added.
Likewise, someone closer to retirement age is likely to reduce their stock allocation to avoid putting money at risk near the age at which they will start bugging their accounts.