We are all familiar with the term “triple threat”. It most often refers to an athlete or performer who excels in three areas. For example, a performer would be considered a triple threat if they could sing, dance and act.
Well, believe it or not, there is a triple threat in the finance world too. In this case, it’s not in reference to a person, but rather an investment tool if used properly. It’s the Health Savings Account, or HSA.
A Health Savings Account is gaining popularity as more and more individuals understand its purpose and use. Only individuals enrolled in a High Deductible Health Plan, or HDHP, are eligible to contribute. The rationale behind that is if someone is enrolling in a HDHP, typically the premiums are lower, but the deductibles are higher. HSA’s act as a savings vehicle where individuals and families can put away money to pay for those out of pocket medical expenses. (See table below for contribution and out-of-pocket limits)
So, how does it work?
Contributions: Contributions are pre-tax and typically done through a payroll deduction. However, you can still contribute if you are self-employed or unemployed, as long as you are still part of a HDHP. You can contribute the maximum amount, regardless of how much you earn. Contributions are no longer allowed when you reach age 65, which is when most individuals are eligible for Medicare.
1st Threat: Contributions are pre-tax
Account Growth: Many people may use their HSA for immediate qualified medical expenses. However, if you can afford to pay for medical expenses with other available cash flow, you can take advantage of the tax-free growth. You may not be aware that you can invest the contributions inside of your HSA, just as you would a 401(k) account. Use the same thought process and invest according to your risk tolerance, while staying diversified.
2nd Threat: Tax-free Growth
Withdrawals: Any qualified medical expenses are distributed tax-free. Examples of qualified medical expenses include doctor and hospital visits, prescriptions, vision care, x-rays and vaccinations. In retirement, you can use your HSA to pay for Medicare premiums and long term care expenses, too. Be aware that you cannot use it to pay for Medigap premiums.
Find a complete list of qualified expenses in IRS Publication 502.
A few things to note:
A.) Before age 65, any distributions for non-qualified medical expenses will be subject to a 20% penalty and income tax.
B.) After age 65, any distributions for non-qualified medical expenses will be subject to income tax only. The 20% penalty goes away.
C.) There are no Required Minimum Distribution requirements at age 70 ½, like there is with a Traditional IRA. A huge advantage.
3rd Threat: Tax-free distributions for qualified medical expenses
So…how should you use an HSA? Use it as a complement to your 401(k) or IRA. If possible, do both. First, think of your HSA as a savings vehicle for current and/or future medical expenses. Second, use it as an added source for retirement income. If your cash flow permits, refrain from using your HSA while in pre-retirement, and pay for medical expenses out of pocket. This will allow your HSA to grow and be available to pay for medical expenses in retirement, when money might be tighter. Remember, if it’s not used for qualified medical expenses in retirement, it will be treated just like your IRA…distributions will be subject to ordinary income taxes.
Take advantage of the HSA if available. It’s a great investment tool that provides a triple threat: tax-deductible contributions, tax-free growth, and tax-free withdrawals (qualified medical expenses).
The table below shows the maximum contributions and out-of pocket limits for 2019 and 2020.
Securities and Advisory Services offered through The Strategic Financial Alliance, Inc. (SFA) – Member FINRA, SIPC. Advisory Services also offered through Strategic Blueprint.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. The SFA does not provide tax or legal advice.