According to William Stuart, an HSA expert, author, and consultant, only 4% to 5% of people maximize contributions to an HSA (Health Savings Account). This is a mistake!
The IRS does not allow you to typically double dip on tax deductions. For example, in your 401k, you can get a tax deduction when you contribute, but you must pay taxes when you withdraw. In your Roth IRA, you pay taxes when you contribute, but get a tax-free withdrawal.
However, HSAs are different; both your contributions and withdrawals are tax-free!!! This is a big deal.
Quadruple Tax Benefits
You may have likely heard that HSAs offer triple-tax benefits (tax deduction when contributing, tax deferral along the way, and tax-free withdrawals). However, there is also one other tax benefit that is rarely discussed.
If you make your HSA contribution through your employer (which you should if allowed), your contribution is also free of FICA Taxes (Social Security and Medicare tax). This is not true with 401k contributions as these are subject to FICA taxes.
Eligibility
Unfortunately, not everyone is eligible for an HSA. To be able to contribute to an HSA, you must first have a high deductible health insurance plan (HDHP). This just simply means that if your health insurance plan has a deductible of at least $1,600 for individuals or $3,200 for families (based on 2024 IRS rules) then you’re eligible to contribute to an HSA – even if your employer doesn’t have one.
You heard that correctly. If your employer doesn’t provide you with an HSA, then you can still set one up on the open market so long as you have a HDHP. Some examples include, Optum, Further, and Lively. Note that if you contribute to an HSA outside your employer, you lose the FICA tax benefit I discussed above. However, it’s still worth it due to the tax-free nature of your contributions and withdrawals.
How to Use an HSA
Many people incorrectly use HSAs. Generally, they contribute less than the maximum allowed ($4,150 for individuals or $8,300 for families in 2024) and then they withdraw from it whenever a medical need arises. If you wish to build your wealth in an efficient way, then listen up. First, maximize contributions to your HSA. Second, once the cash in your account exceeds the HSA minimum (usually around $1,000 or $2,000), invest the excess. Third, if at all possible, don’t withdraw from it until you are age 65. This is the age at which you start receiving Medicare and you can use the HSA to pay for your premiums and other medical costs.
As an example, a 35 year old who has a high deductible insurance plan for his / her family could contribute $8,300 / yr. If done for 30 years at a 6% rate of return, the HSA would grow to around $695,000 by age 65. This amount would be entirely tax-free if used for medical expenses. Any amounts you withdraw for non-medical expenses would only be taxed at your income tax rate. If you are under age 65 and take a non-medical withdrawal, you would be income taxed and also face a 20% penalty tax.
When properly used, an HSA can be a big addition to your retirement nest egg! And it should be treated in the same manner as a 401k or IRA – DON’T TOUCH IT FOR A LONG PERIOD OF TIME!!!
You Can’t Contribute to an HSA Forever
If you start collecting Medicare at age 65, then you must stop your HSA contributions by that age. If you plan to collect Medicare after turning age 65 (if you are working for example), then you must stop your contributions at least 6 months before signing up for Medicare.
Are HSAs more valuable that 401ks?
HSAs are so powerful that we generally prefer that clients contribute to them prior to their 401k and IRA.
As you saw above, contributing $8,300 to an HSA provides a $695,000 tax-free ending value assuming a 6% per year return.
By contrast, if you contribute the same amount to a 401k, earning the same 6% per year, then you end up with the same $695,000. However, the big difference is that 100% of it would be taxable. At a 22% tax bracket, your $695,000 would be reduced to $542,000.
This, in my opinion, makes HSAs far more valuable than 401ks. Better yet, max out the HSA and then work toward maxing out your 401k as the tax benefits are big drivers of investment growth.
We all know the benefits of 401ks and IRAs. But don’t overlook the powerful benefits of HSAs.
Brad Tinnon
CERTIFIED FINANCIAL PLANNER™
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