I recently attended an event hosted by Fidelity in Washington DC. During the event, I spoke with a gentleman who helped write the regulations for several tax advantaged investment accounts back in the late 1990s and early 2000s.
He confirmed a suspicion that I have had for a while when he revealed a little-known secret about an account you may be familiar with: a health savings account.
This tool has been sitting quietly on the sidelines in the world of personal finance since 2003. And you’re seriously missing out if you aren’t using it.
The Emergence of a Powerful Tax Savings Tool
The power of tax deferral has been touted for years. Many take advantage of it by contributing to an employer-sponsored retirement account (like a 401(k) or a Roth 401(k)). You might even participate in both options.
But what if I told you there was another type of account that allowed you to participate in both tax deferral and tax free distribution in retirement at the same time? This account allows you to completely avoid paying taxes on the money contributed.
That’s true when you put money in and when you take money out.
Most people have no idea that this account can actually be used as a retirement planning tool (if they know it exists at all) because of its name. A health savings account doesn’t sound like it’s a key to reaching financial success.
But an HSA is far more than a nice place to stash your savings for doctor’s bills for the year.
The True Power of a Health Savings Account
The HSA was created for people who participate in a high deductible health insurance plan. Since these deductibles are larger than the typical insurance plan, the government allows participants to contribute money to an account, before taxes, and use that money to pay for qualified medical expenses.
This is a nice benefit because you avoid paying taxes on medical expenses that you need to pay anyway, like medical care, prescription drugs, some dental costs and payment for long term care.
But that’s the boring way to use this account.
If you want to boost the power of your retirement savings, it’s time to look into using your HSA in another way.
If you have a health insurance plan that qualifies you to use an HSA, you can contribute up to $3,350 ($6,750 if you are married filing jointly) every year. This contribution is not taxed.
You can then invest this money in mutual funds just like you can inside of a 401(k) or IRA. It’s important to know that not all HSA accounts provide access to investments. The good news is that you can choose to use any HSA that accepts your insurance plan, and don’t have to rely on the one recommended by your employer.
Here’s where the magic happens. By continuing to contribute to an HSA and investing that money year over year from now until you retire, you could create a sizable balance inside the account. You then have a completely tax-free sum of money to use for qualified medical expenses during retirement… a time when you could spend $1,000 per month in medical costs.
Using a Health Savings Account Effectively = Supercharged Savings for the Future
When used effectively, your HSA can act as a supercharged medical IRA account. It can save you thousands on taxes over a lifetime.
And you always have access to this money because there are no restrictions or penalties for tapping into this account before retirement if needed for qualified medical expenses.
Accordingly to new research in the Journal of Financial Planning, you should consider contributing to an HSA account before contributing to retirement accounts or paying down debt. Yes, that means foregoing your employer’s matching 401(k) contribution until you max out your HSA.
Of course, before you make any drastic moves, you’ll want to talk with a financial planner to ensure this is the best strategy for your unique situation. You’re an individual and your goals aren’t cookie cutter. Your financial advice shouldn’t be, either.
The numbers don’t lie — it’s that powerful!
This order of priority isn’t right for everyone, but this is another example of why it’s important to examine your financial decisions with eyes wide open rather than falling in line with what society says to do.
General rules of thumb that work for the majority may not work for your unique situation, and it’s my goal to help you avoid following the crowd when it’s not right for you.