Why do financial planners love Health Savings Accounts (HSA)?
AI's response in regular print | Beverly Hills, CFP®, Joe O'Boyle's in italics
“Why do financial planners love Health Savings Accounts (HSA)?”
Because a Health Savings Account is one of the most tax-efficient investment vehicles currently available, HSA’s are fast becoming a favorite account recommendation for financial planners.
For the 2023 tax year, the maximum pre-tax Health Savings Account (HSA) contributions are $3,850 for individual coverage and $7,750 for family coverage. Financial planners typically recommend contributing the maximum each year and investing the underlying funds within your HSA in a mix of stock and bond mutual funds (or ETF’s) to allow for the potential of tax-fee growth for the long-term.
The Health Savings Account, or HSA, is a remarkably powerful and flexible tool that offers a trifecta of tax benefits – tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. In addition to the well-known use as a resource for out-of-pocket healthcare costs, it’s also a remarkable tool for long-term investments.
Traditionally, HSAs were conceived to cater to High Deductible Health Plans (HDHP), serving as a financial cushion for any immediate healthcare expenses. However, their potential as a long-term investment vehicle is increasingly being recognized, and they are fast becoming a favorite among financial planners.
HSA Eligibility
To be eligible to contribute to a Health Savings Account (HSA), an individual must be enrolled in a HDHP, which is a type of health insurance plan with a higher annual deductible than a traditional health plan. In addition, you cannot be covered by any other health insurance plan that is not an HDHP, such as a traditional health plan, Medicare, or Medicaid. An individual also may not be claimed as a dependent on someone else's tax return.
For retiree’s enrolled in Medicare, while you may no longer make contributions to your HSA, you can use your HSA balance as a tax-free way to pay your Medicare premiums for Part B and Part D prescription-drug coverage.
The HSA Advantage: Triple Tax Benefits
The Health Savings Account has an unparalleled advantage over most other retirement savings vehicles because it offers triple tax benefits. Contributions to your HSA are tax-deductible, meaning they reduce your taxable income for the year. Any growth or earnings from the investments in your HSA are tax-free. Finally, the withdrawals from your HSA are tax-free if they're used for qualified medical expenses.
This is a financial triple play unlike any other. Traditional 401(k)s and Traditional IRAs may offer tax-free contributions, but withdrawals are taxed. Roth 401(k)s and Roth IRAs, on the other hand, provide tax-free withdrawals, but contributions are made with after-tax dollars. Only the HSA offers all three.
Treating HSA’s as a Long-Term Investment Vehicle
While the immediate tax-saving advantage of an HSA is easy to understand, why should one consider it as a long-term investment?
If a 35 year old investor contributed the maximum $3850 per year to an HSA for 30 years and the invested funds earned a 6% annual rate return, the investor would have over $300,000 in their HSA at age 65. Time and compound returns can be an incredibly powerful combination, and especially so in a tax-advantaged account like an HSA.
This strategy means you would pay for current health care expenses from other sources (such as your income or savings) so that you may let your HSA potentially grow and compound tax-free for retirement, much like you would do with a Roth IRA.
HSAs are not "use it or lose it" accounts which means they can be an ideal tool for accumulating wealth over time. Furthermore, after the age of 65, funds from an HSA can be withdrawn for any purpose without penalty — although if not used for qualified medical expenses, they will be subject to income tax.
As we age, our healthcare needs and related expenses tend to increase. Having a significant amount in an HSA during retirement can help cover these costs, and since withdrawals for qualified medical expenses are tax-free, the money goes even further.
Why Financial Planners Love HSAs
Financial planners advocate the strategic use of HSAs for their clients, primarily due to their dual nature: a saving tool for healthcare expenses and a long-term investment vehicle for future needs.
First, the HSA is an excellent method to save for future healthcare costs. According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2022 may need about $315,000 on top of other retirement savings to cover health care expenses in retirement. Therefore, the long-term benefits of tax-free growth in HSAs can be massive.
Second, treating an HSA like a Roth IRA for long-term tax-free growth is a smart strategy. Financial planners recommend paying for current out-of-pocket medical expenses from other resources, if possible, and allowing the HSA to grow tax-free over the years. This way, the account holder reaps the benefits of the 'triple tax advantage' for a longer duration, harnesses the power of compound interest by reinvesting dividends, interest and capital gains, and builds a substantial healthcare nest egg for the future.
Conclusion
Health Savings Accounts are more than just a way to offset medical expenses. They are a powerful tool for long-term financial planning. Used wisely, they offer tax advantages unmatched by any other retirement savings vehicle. The shift in perspective, from viewing the HSA purely as a health care tool to seeing it as an essential part of a long-term investment strategy, can have profound implications for future financial health and stability.
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Joe O'Boyle is the founder and principal of O'Boyle Wealth Management, a full service financial planning and investment management firm, located in Beverly Hills, California. Joe O’Boyle was named to InvestmentNews 40 under 40 class of 2016, and has a catalog of financial planning and investing articles on Money.com & U.S. News. Disclosure information.