Tax-Free Investing. The True Secret Behind Health Savings Accounts.

By Brad Beckstrom

Why would I waste a perfectly good Thursday morning writing about health insurance and health savings accounts? Well, politics has made paying for healthcare a national obsession.

There’s been a lot in the news recently about the spiraling costs of healthcare and Republican promises to cut the costs of health insurance for individuals and families. While no formal plan has been presented, one key component mentioned by both Republicans and Democrats is the Health Savings Account or HSA. The fact is, tax-advantaged HSAs have been around for years. In many ways they are also one of the best ways to save for retirement. I’ll explain why.

What is an HSA?

An HSA used in conjunction with a high deductible health insurance policy allows users to save and spend money tax-free to use for medical expenses. Contributions to an HSA can be made pre-tax directly from your paycheck or you can make contributions on your own that are 100% tax-deductible, up to $3300 for individuals and $6550 for families and, if you’re over 55, you can contribute $7550 per year. For example, a family in the 25% marginal tax bracket could save you over $1600 a year in taxes.

How does it work?

Once you have money in your account, you can then use it to pay for all types of medical expenses, including things like new glasses, prescription drugs, medical and dental visits, and any medical expenses not covered by your high deductible health plan. To be eligible, you need to have a health plan that qualifies as a high deductible plan. (Example a minimum deductible of $1300 for singles or $2600 for families). A high deductible plan means you will pay more out of pocket before meeting your deductible. The advantage is that the premiums on these plans are lower. Due to the high cost of health care, many employers are now offering only high deductible plans, or versions of it, as an option.  For entrepreneurs, these plans are also available through healthcare.gov and labeled as HSA or through most health insurance brokers at comparable rates.

Simplify the process

When I first started researching HSA’s,I felt they were a bit complex. I had to set up a pretax deduction from my paycheck, then set up a HSA account with a participating bank and assure that these pre-tax deductions were transferred into the account. Once the account was set up and funded however, I found it was easy to track medical expenses in Quicken or online using Mint.com or PersonalCapital.com.  Once a month I can pull up my non-reimbursable medical expenses then simply pay myself back from the HSA account. I don’t see a need to save paper copies of the bills as the transactions applied to my deductible are saved by our health insurance provider and they are documented in both the credit card bills and online tracking. The HSA bank account allows you to track reimbursements paper free. You’ll get a year-end statement showing the exact amount of all transactions.

Using an HSA like a turbocharged tax free retirement account.

What happens if I don’t use up my budget? Any leftover dollars stay in the HSA account and can be invested in index funds. This is the true secret behind an HSA account. Unlike an IRA or a 401K, the money in an HSA account is not taxed when you make withdrawals during retirement. After you turn 65, you can also withdraw the money tax-free for any purpose, making it an ideal bookend to a traditional retirement account. Here is a great graphic from The Mad Fientist showing the cash flow.

Setting it up.

Here are some steps you should take if you’re considering an HSA account.

1. Don’t wait until open enrollment period start researching health savings accounts. Find out what your options are now. Healthcare costs in the US are skyrocketing, and many employers, entrepreneurs and government agencies are switching to high deductible plans. You don’t want to be stuck in one of these without an HSA account.
2. Choose which financial institution you’ll use for your HSA account. I was able to quickly set mine up with Bank of America, making it easy to handle transfers between checking and my HSA account. Most HSA accounts offer bill pay and transfer features even if you don’t bank with them.
3. Find out if pre-tax contributions can be made from your paycheck. This lowers your tax bill and gives you tax-free dollars to spend on health expenses you’re going to have anyway, even if it’s new pair of glasses or a root canal.
4. Don’t get HSA plans mixed up with other types of savings accounts like HRAs or FSAs  the key difference is that you own the HSA account and the dollars don’t need to be used up by the end of the year. Make sure it’s specifically HSA approved.
5. Max out your tax-free contribution whenever you can. This money grows tax-free in your HSA account until you use it. The HSA account is especially useful for individuals who have also maxed out their retirement contributions.
6. Another key difference with HSAs is that they have investment options for your leftover funds. Check a balanced index fund and put your extra cash in there at the end of the year. Over time this will grow tax-free.
7. Once you start using your HSA account, pay your providers directly then reimburse yourself from the HSA. Some HSA accounts include debit cards but I found it easier to use a credit card with points and then reimburse myself, which is allowed under the plan.
8. HSAs are great for the self employed you save an additional 7.65% on (employer paid) social security and medicaid taxes.
9. Check out this article with more info about turning your HSA into a souped up retirement account.
10. Call your congressmen and let him know that 100% tax deductible, affordable health care, and HSA accounts, are a good thing that should be improved on, not eliminated.

 

I’d love to hear about your experience with HSAs. A quick disclaimer — Any concepts presented on this blog are simply opinions and should not be considered as professional investment advice.  As with most other things in life, you are solely responsible for your own choices, make them thoughtfully.

 

The Frug

 

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