Pssst? Want to know about a secret savings account? A secret savings account that that is the only triple-tax advantaged account in existence?
A savings account with which you can use the money now or wait until retirement?
Let’s talk about the Health Savings Account (HSA) that has been nicknamed the “Stealth IRA”.
Huh? Triple Tax-Advantaged?
This is the holy-grail in savings.
By using an HSA your money isn’t taxed going in, while growing, or, if you use it for medical expenses when it comes out of an HSA.
Here are some quick details –
- Money put to an HSA is not subject to federal income tax at time of deposit
- Investment returns inside the HSA are not subject to federal income tax as the HSA grows
- Withdrawals are not subject to federal income tax if used for qualified medical expenses.
- HSA funds roll over and accumulate year to year if not spent
There is no chance of losing your funds at the end of the year as is the case with Flexible Spending Accounts (FSAs)
And it gets better.
If you don’t use your HSA for qualified medical expenses you can be withdrawn the money without penalty at any time after you reach 65.
At age 65, the HSA is treated like a Traditional IRA. And like a Traditional IRA you’ll only pay income taxes. This is great news if you are worried about over saving for medical expenses and especially rewarding if you have already maxed out your 401K and IRA and need more space for tax protected investments.
Sign Me Up for an HSA!
An HSA is only available if you’re enrolled in a high-deductible health plan (HDHP).
So, what counts as an HDHP?
To count as an HDHP a health insurance plan must have a deductible of $1,300 or greater (indexed to inflation).
This means if at work you have a high-deduction health plan, health savings accounts are the way to go.
The money deposited into an HSA is yours. If you end your HSA-eligible insurance coverage, you no longer have the ability to deposit further funds. But you keep the money you already put into the HSA.
HSAs And State Tax Treatment.
The way states deal with health savings accounts is varied.
Three states -Alabama, California and New Jersey do not recognize HSAs and do not allow deductions of HSA contributions for state income tax.
In New York City, contributions to an HSA will be free of federal, state and local income taxes.
Death and HSA Accounts.
When an HSA account holder dies, the funds in their HSA are transferred to the beneficiary named on the account.
If the beneficiary of the HSA is a spouse, the transfer of funds is tax-free.
For beneficiaries other than a spouse, the account is no longer an HSA. It becomes taxable to the beneficiary in the year the health savings account owner dies. Keep this in mind when planning your estate. I would much rather my daughter receive a roth IRA that she can stretch across her lifetime tax free then a large HSA. So, if funds are large and your health has been good. I would spend this down in retirement first over a Roth IRA.
If there are qualified medical expenses for the decedent then the amount taxable to the beneficiary is reduced by that amount if they are paid by the beneficiary within 1 year after the date of death.
Managing your Health Savings Account
There are three ways you can treat your HSA
HSA as Stealth IRA
If you treat your HSA as a retirement account you can max out the account every year and it gets invested in the market. The hope would be that it will compound and grow until retirement.
If misfortune hits and you have an expensive medical problem you can use the health savings account funds to pay for the medical expenses.
If you reach retirement without touching the HSA funds, they can be used as part of your asset strategy.
So you can
- Continue to hold the funds and use them for qualified medical expenses – never paying taxes on the money
- Withdraw the funds and pay low income taxes
- Withdraw the funds using receipts for medical expenses incurred over the years prior to retirement
Number 3 is what I plan on doing. I will keep receipts for my lifetime and use cash to pay my expenses. This way the money continues to compound in the market and I wait for reimbursement.
HSA For Current Out-of-Pocket Medical Expenses.
You can always use the health savings account to pay for current out-of-pocket medical expenses.
There are plenty of opportunities to use the funds to pay for current expenses as there is a broad definition for qualified medical expenses,
The goal is reduce the drag of taxes on your retirement and savings and a little of tax planning will help you to reap significant rewards.
You can use HSA funds to pay for current medical expenses and help make progress to this goal.
Saving Receipts for Future Expense Reimbursement
There is no provision that says when you have to make a reimbursement on your medical expenses.
You can incur a qualified medical expense today but apply for a reimbursement later – even many years later.
The benefit to waiting is that your money is compounding tax free during the interim.
And then it can then withdraw it in retirement without having to pay expenses.
What Types of Investments Can I Make with HSA Funds?
An HSA can be invested in the same way as a 401(k) or an IRA, depending on the options offered by your HSA provider.
Can I Switch HSA Providers?
You are not required to use the HSA provider selected by your employer, unlike a 401(k).
You can use any provider you like.
If you choose to use a separate HSA provider, make sure your employer sends the check directly to them so that you can save on payroll taxes.
Now you know about the super-secret savings account the HSA aka the “Stealth IRA”.
If you have a high deductible health plan you will have access to an HSA and you can use it to bolster your retirement.
Make sure you talk to your HSA provider and tax professional to determine how to effectively invest your money.