As the year goes by, I can’t help but imagine the day our retirement accounts will be maxed out. Between my lovely girlfriend and myself, I expect we are still at least a year away from contributing the max to both our IRA’s and 401(k)’s. To the detriment of making this goal happen anytime soon, I stumbled upon another retirement vehicle, one that we both were missing out on for years; a Health Savings Account, aka an HSA.
In 2016, I will benefit from tax savings of $1,220 by placing $2,130 of my take home pay into such an account. Here’s How:
An HSA allows me to avoid paying an extra $1,220 in taxes all while contributing a max of $3,350 into my retirement accounts (The maximum contribution in 2016 for a family is $6,750 with an additional $1,000 allowed if you are 55+ years of age).
How does this work exactly?
By offering a benefit that IRA’s and 401K’s don’t.
HSA contributions are made via payroll deductions that allow you to avoid paying FICA taxes (7.65 percent from Social Security & Medicare) AND income taxes (currently 25% for my tax bracket plus an additional 3.75% for my home state of Illinois.)
Working backwards from my take home pay, that means for every 64 cents I contribute to my Health Savings Account, the account is funded a full dollar. This happens because the other 34 cents come from the taxes I would have otherwise paid had I not contributed to the account.
You can now see why such an account is a powerful tool in the early retirement toolbelt.
You can pull the money out tax-free via qualified medical expenses years after you actually incur those medical expenses. If you don’t incur medical expenses, you can still pull the money out at a later date but more on that below.
Is an HSA right for you?
Before you run off to sign up for an HSA, there are a few things to consider.
First off, HSA’s are not available to everyone as not every employer offers the benefit option of having an HSA.
Second, HSA’s are linked to high deductible healthcare plans. So, if you expect a large amount of medical bills for yourself or your family in the following year, you will likely benefit more from choosing an alternative option such as a low deductible, high premium health care plan rather than a high deductible option with an eligible HSA.
Third, some HSA’s are tied to high fees and limited investment options. Before choosing to opt into an HSA program, be sure to understand the fee structure you are signing up for.
Since people are eligible to open their own account, you do have the option to shop around at different service providers. If you elect this route, you will need to work with your HR and notify them you intend to open your account with another broker. In most cases, employers are flexible enough to accommodate.
Once you have enough funds in your HSA, often a minimum of $1,000, then you can begin to invest this money similar to any other type of retirement account.
If an HSA looks right for you, you can turn it into a tax savings vehicle that is unmatched when compared with traditional retirement accounts.
Have your cake and eat it too. (insert pic of me on crutches stuffing a cake into my face)
What does the IRS have to say about this?
Funny you should ask.
It just so happens that part of my job as a CPA is to dig through tax code and when I did, I found this gem:
“You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA…You do not have to make distributions from your HSA each year.” (Page 8 of IRS Publication 969 (2015))
In other words, as long as you keep your receipts to show you have had qualified medical expenses since opening your account, you can withdraw your HSA funds at any point, tax free. That’s right. Any point. Tax free.
But what if I don’t have any medical problems and don’t qualify for medical expenses??
If you manage to get to 65 without ANY medical bills, then the HSA essentially converts to a Traditional IRA. The money in the account can then be distributed penalty free and will only be subject to ordinary income taxes.
Many employers are now offering high deductible medical plans, so seeing an HSA option is becoming more and more popular.
When you select your coverage, I would encourage you to see if an HSA makes sense for you.
Have you considered using an HSA in the past? Did it make sense for your situation?