The problem is they are often used incorrectly by investors. Most investors ignore their potential and keep their HSA assets in cash. But that truly is a losing strategy. Moreover, they forget to max out these accounts in favor of other retirement or savings vehicles.
For retirement success, using HSA first could be the best strategy for long-term wins.
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But like many accounts and savings vehicles, over time, we’ve discovered that many of the loop-holes and features can be used differently than directly intended. For HSAs, this comes down to various tax benefits. The accounts offer the trifecta of tax wins.
For starters, contributions to an HSA are tax deductible and many employers allow you to make the deposits with pre-tax money. As such, this reduces taxable income today and decreases the amount of money you need to send Uncle Sam in the current tax year. Secondly, these accounts allow savers to enjoy tax-deferred gains.
Interest, dividends and capital gains within an HSA are not subjected to taxes. This allows for tax-deferred/free compounding. Finally, HSA accounts allow for tax-free withdrawals when it comes to qualifying medical expenses.
This trio of benefits makes for a powerful combination for long-term growth.
However, that is a losing strategy.
Like a 401(k), HSAs offer tax deduction today and tax-deferred compounding. However, 401(k)s lack the ability to have tax-free withdrawals. Pulling money out is subjected to ordinary income tax rates. An additional hit against 401(k)s, Uncle Sam will only compound tax-deferred for so long. With that, 401(k)s force you to begin withdrawing funds at a certain age – dubbed required minimum distributions (RMDs) – and pay taxes on those funds. This isn’t true with HSAs, and investors can leave funds in the accounts indefinity.
An added bonus to HSAs is that there is no time limit for medical expenses to occur. As long as you keep a record/receipt of your expenses, you can wait 10, 15 or even 30 years to pull the money out of your HSA account to get the tax-free withdrawal. So that means, if you pay a doctor’s bill today, you can wait until you’re retired to get reimbursed for that expense. And with many HSA plan sponsors now offering digital record-keeping of expenses, this becomes easy to ensure tax-free withdrawals later on.
And if you don’t happen to have receipts or medical expenses, HSAs have similar tax consequences to regular 401(k)s when making non-qualified withdrawals.
The next piece is making sure that you get the most out of long-term compounding of these HSA dollars. The default option for many health savings accounts is a cash account – often tied to a debit card. After meeting minimum requirements – often an account value of at least $2,000 – investors can choose various mutual funds and other ETFs to invest in. Some providers like Fidelity will even let you buy individual stocks. Using HSA funds as part of an overall asset allocation strategy is key.
Finally, keep and digitize all your receipts. Aside from hospital stays, doctor visits and prescription drugs, HSA dollars can be used for nearly anything health-related including over-the-counter medicines and first aid products. Having a record of all of this can help you pull money out of your HSA later on during retirement for tax free withdrawals.
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