Health Savings Accounts (HSAs) are a popular benefit that employers can offer to help their employees save and pay for qualified medical expenses. But an HSA can also act as highly effective wealth-building tool due to their unique — and powerful — tax benefits.
An HSA is a tax-advantaged savings account that is a great option for people who get their insurance coverage through high-deductible health plans (HDHPs). The high deductibles associated with health insurance can be daunting for many. But when you combine an HSA with your HDHP, you can pay that deductible, plus other qualified medical expenses, using the money you set aside in your HSA.
The reason you should consider using an HSA alongside an HDHP is that the former is tax-advantaged. This gives you a lot of room to generate savings that will prove useful in your later years.
HSAs are impressively tax-efficient. This is because they offer three specific tax advantages:
- The money you contribute to your HSA is tax-deductible, meaning that you can deduct the amount you put into your HSA from your taxable income (this may occur automatically through an employer plan).
- Once your money is in your HSA, you can invest it. And you don’t have to pay taxes on your capital gains and dividends.
- As long as you use the dollars in your HSA on qualified healthcare expenses, you won’t pay taxes on the money you take out of your HSA either.
Building Wealth Using Your HSA
Healthcare will most likely be your biggest expense you face as you get older. To stress this point, consider the Fidelity Retiree Health Care Cost Estimate, which underscores that an average retired couple aged 65 in 2021 will need around $300,000 saved (after tax) to cover healthcare costs in retirement. This is why you need to be able to build wealth in the long term.
Fortunately, with an HSA, you have the ability to build wealth, and enough wealth to ensure that you can cover all of your medical expenses during retirement. Here are some basic tips that will allow you to achieve this:
Start Contributing to Your HSA Now: If you’ve got some way to go before you turn 65, then you can benefit a lot by setting up an HSA now and regularly contributing to it.
Invest Your Contributions: One effective way to maximize the money-making potential of your HSA dollars is to invest them. There are several investment vehicles you can utilize, including mutual funds, stocks, bonds, exchange traded funds and more (depending on your account).
Don’t Touch the Money: This is the real key to building wealth using your HSA. If you want to build wealth from your HSA, then you ideally want to leave your contributions in your account to let them grow until you reach your 60s or 70s. If you take money back out, even to pay for medical bills today, you will limit the HSA’s ability to grow over time.
You want to invest your contributions and then keep those funds invested over the span of decades, allowing you to make the most of compounding returns. HSA funds that you don’t invest in the market usually earn an interest rate that is comparable to a savings account.
If you face healthcare costs that you need to pay now, you can fund those expenses through other means. Typically, this would involve dipping into your regular monthly cash flow. This should be manageable when it comes to something like a $50 co-pay to see a doctor. However, for more substantial expenses, a combination of using part of your monthly budget and part of your cash savings may be adequate.
The longer you keep your funds invested and continue to contribute to them, the more value you’ll see in your HSA over time (and remember this growth is tax-free). When it comes to an HSA, what matters the most is not market timing but time in the market.
Why Save Using Your HSA
Let’s say you’re 30 today and you contribute around $300 to your HSA every month, with a 4% rate of return (compounded annually), which is a relatively conservative rate of return over the next 35 years. By the time you hit your mid-60s, you could have easily saved enough to use for your healthcare expenses in retirement.
There are several other benefits to using money invested in your HSA to pay for medical expenses when you’re in retirement. These funds can be used:
- Tax-free to cover medical expenses even when you’re no longer employed
- To pay for Medicare premiums for Part B and Part D, and prescription drug coverage
- To cover any gaps in coverage should you retire before qualifying for Medicare or if you lose your job
- To cover non-qualified expenses penalty-free (if you’re 65 or older)
An HSA isn’t necessarily right for everyone. You also need to be prepared to handle the cost of a high deductible in case you need to see the doctor more often than you were prepared for (which can happen to anyone). Nonetheless, if you have an HSA and want to use it as a wealth-building tool, then it’s worth keeping the above points in mind. A little strategy can go a long way.
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