My eyes lit up as I was reading through the list of new benefits that would be offered by my employer back in 2019. Beginning the following year they would begin offering a Health Savings Account (HSA). At the time, I didn’t really know what that meant. What I did know was the personal finance community touted this as the holy grail of retirement accounts.
Immediately I was confused. How can something called a health savings account be used to fund retirement? What’s all this talk about triple tax benefits? First of all, “savings accounts” in general have received a terrible reputation given that they’ve paid almost no interest for more than a decade. Second, how can an account set up for health care expenses be used to fund retirement? That led me on a journey digging through countless amounts of information trying to answer these questions. The rest of this post will take you on that journey and land where we are today. Fully funding and investing in our HSA, while paying qualified medical expenses out of pocket.
What Is a Health Savings Account (HSA)?
First, let’s start by going over the definition of a Health Savings Account (HSA). According to the IRS website:
“A Health Savings Account (HSA) is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to qualify for an HSA.”
So what does this mean in plain English? The intended purpose of a HSA is to allow you to pay for medical expenses tax-free. Additionally, a HSA allows you to invest money in stocks or other funds similar to how you would invest money in a 401k or individual retirement account (IRA). That money is then available to use for qualified medical expenses.
The tax benefits of a HSA are significant. When HSA dollars are used for qualified medical expenses, the tax benefits are even better than a 401k or IRA. With a 401k or IRA you have to choose if you’d prefer your dollars to be taxed up front (Roth) or on the back-end (Traditional). HSA’s provide triple-tax benefits, which means you can invest in your HSA with pre-tax dollars, grow those dollars tax-free, and withdraw tax-free when used for qualified medical expenses.
With a HSA you can fund annually up to $7,200 (for a family filing jointly) or $3,600 (for an individual). HSA’s are usually only available with higher deductible and lower premium insurance plans. When my company started offering a HSA option I switched from our best plan which had a high annual premium (I was paying almost $8,000 per year in insurance premiums) but had very few out of pocket expenses, to a higher deductible but lower premium plan (about $1,500 per year) but I have to pay much more out of pocket.
Since the out of pocket maximum is only $6,000 per year, it would cap pretty quickly if a serious medical situation happened. However, there are frequent payments until we hit that $6,000 threshold and especially until we meet our $2,600 annual deductible.
How to Maximize the Benefits of a HSA
Hopefully you are still tracking with me. You may be wondering, if I have a higher deductible plan and therefore have to pay more money out of pocket, how will the investments in my HSA ever grow?
This is our second year with a HSA and we’ve funded the maximum amount each year ($7,100 in 2020; $7,200 in 2021). Last year whenever we had a medical expense we used money from our HSA to pay the bills. Our medical expenses ended up being about $3,000 and I’ll admit it was really nice to just make that payment from the HSA and not worry about it. The downside though is that $3,000 is now out of the HSA and cannot be invested and grow tax-free over potentially several decades.
This year we decided not to pay our medical bills from our HSA funds. This is where the magic of a HSA comes into play. Last month we received a bill for $1,200. One option would have been to pay that bill using money already in our HSA. However, this year we started paying any bills out of pocket from our savings. Therefore, since we aren’t pulling that $1,200 out of our HSA it can continue to grow tax-free for decades until we reach retirement.
Even better, since we saved the $1,200 receipt, we can pull that money out of the HSA tax-free at any point. If we pull out sooner rather than later we’ll miss out on the growth over the years, but it’s still nice to have the ability to have access to that money tax-free if necessary. We save all of our qualified medical expense receipts in a Google Drive document.
Therefore, of the $10,000 currently in our HSA, we have medical receipts totalling about $3,000 that we could pull out at any time without penalty. The plan is to let that money grow for several years, but it’s also nice to know we have access to that money if needed. It essentially becomes another emergency fund that we hope to never use but is assuring to know it’s there.
How Much Will Our HSA Be Worth At Retirement?
I am almost 40 years old and right now am planning to work until age 55. Therefore, if we assume regular contributions of about $7,500 per year for 15 years, plus an additional 10 years of growth until age 65, we’ll have accumulated about $425,000. This assumes a 7% interest rate. Given that we are getting a late start in life with our HSA, there isn’t as much time for compounding.
Steps to Set Up Your HSA for Retirement
Using a HSA to fund retirement is a personal decision. While this is not financial advice, if you wanted to consider doing the same here are the steps you’d want to follow.
- Step 1: Determine if your employer offers an HSA option and enroll if available. If you are self-employed there are also options as long as you are enrolled in a HSA-compatible health plan.
- Step 2: Fund your HSA account. The maximum annual contribution for 2021 is $7,200 and will likely increase slightly every year or two.
- Step 3: Pay medical expenses out of pocket and invest your HSA funds. This is the key if you want long-term compound growth in your HSA. My HSA is currently invested in a low-fee S&P 500 index fund. Make sure you take the time to invest your HSA money or else it will sit in a regular account and not accrue any interest.
- Step 4: Save your receipts for qualified medical expenses. We save all of our receipts in a simple Google Document that can be accessed through Drive. Saving your qualified medical receipts allows you to pull out money any time tax-free (though even better if you let your money grow over the years).
That’s it! Then you just need to sit back and let your money compound. The hardest part in all of this is paying for your medical bills out of pocket. If you end up going with a high deductible HSA-compatible plan ensure that you know the maximum annual out of pocket that you could potentially pay in a year. You’ll also need to have the savings to be able to pay for any medical expenses out of pocket.
Our maximum annual out of pocket with out HSA-compatible plan is $6,000. Therefore, going forward we will put $6,000 aside so when we pay for our medical expenses outside of our HSA it won’t sting as much.
I know this can all be a bit confusing, so if you have questions please let me know. Thanks for reading!