The Neglected HSA

For most folks, it’s easy to participate in your employer’s retirement plan, such as a 401k or 403b. Savvy savers also look at whether they can afford to invest in Roth IRAs or even back-door Roth IRAs. Health Savings Accounts (HSAs) get a lot less attention, but they can be a powerful place to save money.

First, know the basics: To contribute to an HSA, you have to participate in a high-deductible health plan (HDHP) with certain deductible thresholds. Check your coverage to make sure you are eligible. In 2018, individual investors can contribute $3,450 per year to an HSA. The family limit is $6900 *$6850. And investors over age 55 can add on a “catch-up” contribution of $1,000. There is no income limitation on HSA contributions as there is with a Roth IRA.

An HSA is a remarkably tax-advantaged investment

You get an up-front benefit because the amount you contribute is deductible on your income taxes. Further, the value of the HSA accumulates tax-free. Lastly, when you take out the money, the money may be income tax-free. (If you are younger than age 65, you can use HSA dollars to pay for (or reimburse yourself for) qualified medical expenses. Once you reach age 65, you get additional benefits. You can then use HSA funds to pay certain types of premiums. And distributions not used for qualified medical expenses are taxable, but there’s no penalty.)

This brings us a creative way to use HSA funds. Investors often assume that you can only reimburse yourself for medical expenses in the same year. But there is no such rule! So, one strategy is to open an HSA and carefully save your records of qualified medical expenses over the years. Then, once you retire, you can reimburse yourself from the HSA for all those past years’ medical expenses incurred after your HSA was established. The result is income tax-free distributions from your HSA after you retire (or whenever you need the money!).

When you think long term like this, the HSA starts to sound a lot like a deductible IRA AND a Roth IRA. You get the income tax deduction for contributions AND the money comes out later tax-free. It’s a win-win!

One follow-up question I often get is, “What’s the point of doing all that if the money never really grows inside the HSA?”

This is a savvy question. With interest rates so low, the benefit of the income tax-free withdrawal loses its appeal if the money never actually grows. But many institutions do offer a selection of mutual funds in which you can invest (kind of like a 401k) inside your HSA. This allows you to build a portfolio that could grow over time.

*In March the IRS adjusted downward the family contribution maximum from $6900 previously announced to $6850. Make sure you adjust future contributions to accommodate the change.