Updated November 2017
For those of you working for large employers, it’s that time of year again – annual benefits enrollment time – wahoo! The one time of year when you can take a look at what benefits are being offered, see what’s new and try to figure out what you need.
Unless you have a major life milestone like a marriage, birth or death, this is likely the only time during the year that you will able to modify your benefit selections. With that in mind, I thought I would shed some light on one of the increasingly common but least understood health benefit, the Health Savings Account (HSA).
I think it says something about the complexity of the U.S. federal tax code that one of the best retirement accounts available was actually designed to pay for healthcare expenses. The HSA has been rising in popularity each year for the past several years. In fact, in 2016, 72% of large employers offered them, which is up from 40% in 2010 according to the National Business Group on Health.
How HSAs Work
Although you can set up an HSA on your own, the vast majority of accounts are employer-sponsored. They are only available if you have a high-deductible medical insurance plan and the accounts are used to pay for your out of pocket medical expenses.
You fund them with direct deductions from your paycheck and the IRS puts an annual cap on how much you can contribute. In 2017, the cap was $6,750 for families or $3,400 for individuals. If you are 55 or over, you can add an extra $1,000 per year as well. In 2018, the cap for families is increasing to $6,900 and for individuals, it is increasing to $3,450.
HSA’s Tax Benefit – The Best Retirement Account
The reason the IRS caps your contributions is that these funds are tax-deductible. If you don’t know why this is a big deal, you should read, The Brutal Effect of Taxes on Your Savings. Not only are they tax-deductible during the year that you make the contribution, but they are also tax-free when you withdraw them for qualified medical expenses.
Let me repeat that, they are tax-free. As long as you use the money for medical expenses, then not only are your deposits tax-free, but your returns are tax-free and your withdrawals are tax-free. That’s huge!
So, what happens before you withdraw the money for medical expenses? It sits in a brokerage account where you can keep your funds in cash, or invest them in the stock market, similar to an IRA. A good strategy is to keep a year’s worth of healthcare expenses in cash and then invest the rest in the market just like your other retirement accounts.
The HSA Tax Benefit You Didn’t Know About
A better strategy, if you can afford it, is to max out your HSA contributions each year and then pay all of your medical expenses out of pocket without withdrawing anything from your HSA. Each year, your investment returns continue to grow and compound!
Keep all of your medical receipts and later, perhaps after you retire, you can reimburse yourself for all of those prior medical expenses, even if they were years ago. Just hold on to your receipts! This feature is what makes HSAs one of the best retirement accounts around.
Imagine if you invested $6, 750 each year and it compounded tax-free with 7% returns. After 10 years you would have access to $93,000 of tax-free money. After 15 years, you would have $170,000!
The Bottom Line
Now that annual enrollment time is upon us, it’s a good time to look at your options. If you have the opportunity to take advantage of an HSA account, you should give it serious consideration and max it out 100% if you can.
It’s not just a healthcare account, it’s also the best retirement account you didn’t know you had. And it just might be the key to achieving the retirement you always dreamed of!
Do you have access to an HSA account? Did you realize what a powerful retirement savings tool it could be? Are you maxing it out?