Health savings accounts (HSAs) are one of the most underrated and underutilized tax saving vehicles available available. While some people may be aware of the typical ways to utilize an HSA, there are some unique financial planning strategies that you may want to consider implementing.
Some people are using HSAs as a stealth IRA by collecting and accumulating receipts for medical expenses, but not taking distributions from the HSA until much later in life so that they can maximize the period of time for tax-free compounding. There’s no time limit on the look back for qualified medical expenses, so good recordkeeping goes a long way here.
Fund Retirement with an HSA
If you’re over 65 years old, you can roll HSA balances into a regular IRA and spend the funds on non-qualified health expenses without a penalty. However, if you do so, distributions from the IRA would be taxable and balances are subject to required minimum distributions (RMDs) after age 70.5. On the other hand, there’s always the risk that Congress changes its mind on the tax-free distribution feature of HSAs, so some would advocate for using HSA balances sooner rather than later.
Maximize Social Security Income
If you use your HSA in retirement for only qualified medical expenses and don’t roll it into an IRA, you could benefit by having fewer of your Social Security benefit dollars taxed in retirement. Up to 85% of Social Security benefits can be taxed for couples with provisional income over $44,000 in retirement. RMDs from large IRAs can push many people over these thresholds. You can help minimize this by prioritizing saving in your HSA rather than in your IRA or 401(k).
Evaluate Health Insurance Plan Trade Offs
While choosing the right health care plan for your family should be the main priority, and you wouldn't want to take an inferior health plan just to save money on taxes, some people may want to consider the impact of an HSA when they are evaluating their health insurance options. The benefit of the maximum $6,900 deduction in 2018 to a family may outweigh the additional annual deductible costs of the high-deductible health plan (HDHP), versus having no HSA deduction with the higher premiums and lower deductible costs of a non-HDHP. The key is to work with your CPA to evaluate each of these variables and determine the true after-tax costs.
Roll IRA into An HSA
The IRS allows you to do a one-time rollover of IRA money into an HSA up to the annual limits. This could be a great strategy if you have an upcoming large medical expense, but don't have the cash to fund the account. Following the rules on this strategy is imperative, so it's best to coordinate this with your CPA. The funds will have to go directly from the IRA to the HSA, and you have to still be enrolled in a HDHP.
Tax Benefits and Savings
Saving in an HSA can save you a tremendous amount of money. To see the benefit over time, I calculated how much would be in an HSA versus a regular taxable brokerage account if you maxed out an HSA every year for the next 30 years versus putting the same amount in a regular taxable account. We assumed a 3% inflation rate, 6% investment return, 70%/30% stock and bond allocation, stock turnover of 20% per year, 24% ordinary income rates and 15% capital gains rates. After 30 years, the HSA would have $762,000, while a taxable account would have $698,000.
The difference of $64,000 would just be the benefit of tax-free compounding and tax-free distributions. We calculated the compounded benefit of the cumulative annual deduction from the HSA contributions to be another $178,000 after 30 years. You could get a total benefit of $242,000 from maxing out your HSA, and if you’re marginal tax rate is over 24% this benefit would be higher.
While the HSA's triple tax benefits make them attractive for many families, it shouldn't be your only savings vehicle. The HSA contribution limits aren't high enough to fully fund retirement for most families. In addition, HSAs aren't good accounts to save for buying a home, build your emergency fund or fund your children's college education.
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