What if I told you that you have access to an investment account that is better than a 401k or an IRA? An account with tax free contributions, tax free growth, and tax free withdrawals for qualified expenses. You even avoid paying Social Security and Medicare taxes if you contribute directly from your paycheck. (That’s more than you can say for any other account).
Today I want to explore the Health Savings Account (HSA) and how you can use it to build wealth and retire earlier.
High-Deductible Health Plans
You are eligible to contribute to a Health Savings Account if you are enrolled in a high-deductible health plan. A high deductible in this context is one that is at least $1,300 for an individual or $2,600 for a family.
The standard tradeoff with high-deductible plans is that you pay a lower monthly premium than with other plans, but if you get sick you end up paying more before hitting your deductible than with other plans. (Although, it is important to note that high-deductible plans cap your total out-of-pocket costs. The maximum in 2016 is $6,550 for an individual and $13,100 for a family).
The (relatively) newly-added benefit for the high-deductible plans is access to a Health Savings Account
With open enrollment coming up, you can check out which plans are available to you and decide if a high-deductible plan is the right fit for your family.
Contributing to an HSA
Once you have enrolled in your high-deductible plan, you can set up and contribute to your Health Savings Account. This allows you to save for future medical expenses so that the higher deductible doesn’t have to cut into your emergency fund.
There is a limit to how much you can contribute to an HSA. In 2016, that limit was $3,350 for an individual or $6,750 for a family. These numbers go up over time, similar to the 401k and IRA limits.
Also like a 401k or IRA, you can invest the money that you have in your HSA. You will have an option of different mutual funds or stocks and bonds to choose from and will have the opportunity to grow the money that you have in your account. Some accounts have limitations on this. The company that maintains my HSA requires $1000 to remain in cash at any given time and will sweep the rest of the contributions into whatever mutual fund I designate.
Any money contributed to your HSA becomes yours. It does not disappear at the end of the year like a flexible spending account. You do not lose it if you switch jobs. You don’t lose it if you switch out of your high-deductible savings plan.
Once money is in your account, it is yours until you spend it.
Withdrawing from an HSA
Once you have some money in your HSA, you can use it for any qualifying medical expense. (A general rule of thumb is that this can apply to any medical costs other than over-the-counter medication, but if you have a specific question, check out the IRS’s Health Savings Account description.)
Most accounts will give you a debit card that you can use at the point of payment to withdraw money directly from your HSA. Alternatively, you can pay with your own money out of pocket and then reimburse yourself from the account.
What makes this especially powerful for the financial independence and early retirement crowds is that there is no deadline for paying yourself back. As long as you save your receipts (or scanned copies of them) you can withdraw the money at any point in the future.
This means that you can spend money on health expenses in 2016, let your HSA money continue to grow, and then withdraw it in 2020 when you want to put it towards a new car. You pay no tax or penalty on it as long as you have your receipts from the health expense, and the growth from leaving the money invested for an extra four years gets to keep growing for use in the future.
(For more detail on using your HSA as a tool for financial independence, I recommend checking out this post from the Mad Fientist.
If you still haven’t withdrawn your HSA money by the time you are 65 (and you are lucky enough not to have ongoing medical expenses at that age), then you can withdraw the money for any purpose without penalty.
You will have to pay income tax on withdrawals for non-health expenses, but you get to keep the benefits of tax free deposit and tax free growth. Essentially, the account can be used as an IRA for retirement expenses after 65 in addition to being a tax-free way to pay for health care costs.
So take a look at your situation and your health insurance options during open enrollment to see if a high-deductible plan and health savings account may be right for you. It could become your new favorite way to invest.