It’s interesting that one of the secret weapons of a solid retirement plan is including an account that’s not actually a retirement account.
What is an HSA?
A Health Savings Account (HSA) is a tax-advantaged savings account available for people who are enrolled in a high-deductible health insurance plan (HDHP).
As health care costs have dramatically risen, so have the insurance premiums. These high-deductible plans offer lower monthly premiums, but the individual is responsible for paying the first medical bills out of pocket every year. This cost is typically between $5-$10k for the year. So as a way to make these costs a bit more doable for individuals and families, the HSA was formed.
Think of an HSA as a retirement account but for your medical bills. “
Contribution Limits
For 2021, the HSA contribution limits have increased.
An individual with self-only coverage under an HDHP can contribute up to $3,600. For those with family coverage, the limit is $7,200. Similar to an IRA, you can fund this account with pre-tax money. Also unlike other retirement accounts, there is no income restriction. Anyone with an HDHP can open up this account.
The reason why this account is so powerful is because it offers a triple-tax benefit.
Triple-Tax Benefit
This means you can:
(1) contribute to the account on a pretax or tax-deductible basis
(2) your savings grow free of taxes over time
(3) you can also make tax-free withdrawals to cover qualified medical expenses.
Contribute on a pretax or tax-deductible basis
When you put money into an HSA it lowers your taxable income. Some employers may allow you to contribute via payroll or alternatively, set it up yourself and be able to use it as a tax deduction when you file your taxes.
Your savings grow free of taxes over time
This is pretty self explanatory. You do not have to pay any taxes on any of the money in the account. The amazing part of this is that most HSA providers allow you to invest the money into the stock market.
Here is an example in my own life.
I am setting up my HSA account this month with Fidelity. I chose Fidelity because I liked that they had no minimum investment requirements, they don’t have fees and I liked the fund choices. I plan to at least max out the individual contribution limit of $3,600 in 2021 and plan to invest these funds in the Fidelity 500 Index Fund (FXIAX).
I am 32 years old. If I contribute $3,600 every year into this account until age 65, my estimated HSA balance will be $800,000.
If I contribute the maximum amount for a family of $7,200 every year until age 65, my estimated HSA balance will be $1,600,000.
Both of these scenarios estimate a 10% annual return which is on the conservative side of what the 500 index fund typically returns.
Throughout my life I can draw from those accounts as needed if medical issues or expenses arise earlier in life and I need to access those funds. But if I remain healthy and don’t need to tap into those accounts, I can simply let it grow.
You can make tax-free withdrawals to cover qualified medical expenses
Withdrawals from an HSA are tax-free unless they’re used on non-medical expenses. If you use HSA money for a non-qualified expense before the age of 65, you’ll have to pay a 20% penalty on top of income tax.
However, once you turn 65, your HSA is treated like a traditional IRA (retirement account). This means that if you withdraw money for something other than a medical expense, that 20% penalty no longer applies. Like a traditional IRA, the HSA withdrawals are only subject to income tax.
Click here for a full list of medical/dental expenses that do qualify.
Difference Between an FSA and HSA
They may sound like similar accounts, but an HSA is very different from a Flexible Spending Account (FSA). With an FSA account, you lose any money in the account that you don’t spend during the year. With an HSA, you can continue to roll your funds over ever year and can leave your money to grow for as long as you want.
How to Fund Early Retirement with an HSA
Quite possibly one of the coolest hacks for people who are retiring early is to pay for your medical expenses using your regular bank account. If you save the receipts, you can withdraw money from an HSA at any point later in life (as long as you save the receipts). So essentially you can pay yourself back for those expenses years later.
Example
Let’s walk through an example of what this could look like.
Let’s say over the course of 10 years, Jane contributes to her HSA account every year. She has medical expenses that total $3,000 every year. But instead of taking $3,000 out of her HSA account each year to cover her medical expenses, she pays for these out of pocket just using her regular bank account. Jane makes sure to keep those receipts.
Jane retires by age 45 and won’t be able to access some of her retirement accounts until she turns 59.5. Jane can withdraw money that she needs for every day living costs from her HSA, both tax and penalty free, because she will use the medical receipts she saved from years prior to reimburse herself.
Pretty cool huh?!
Conclusion
As medical costs continue to increase, it’s important to make sure you and your family are covered in the future. The HSA makes me feel more secure knowing that I can earmark dollars to cover those healthcare costs, avail of some pretty awesome tax advantages along the way and also know that if I don’t end up needing to use those funds for medical costs, I can tap into that money after the age of 65 and essentially have an extra retirement account.
Want to play around with the numbers yourself? Here is a link to the calculator I used.
I’d love to hear from you. Do you currently have an HSA account? Do you have any questions about it?
