At Bowen Financial Services, LLC, we often work with clients to reduce their lifetime taxes.
When most people think of their retirement accounts, they have pensions, IRAs (Individual Retirement Accounts), and 401k’s come to mind. Very few Americans are familiar with Health Savings Accounts (HSAs) and even fewer are aware of how potent HSAs can be as investment vehicles for retirement. To understand this potential, it is best to relate HSAs to account types that are more traditionally considered as retirement funds.
Qualified retirement accounts like IRAs and 401ks offer investors an advantage to growing retirement funds over normal brokerage accounts. This advantage manifests through an individual’s ability to put funds into these accounts tax deferred. Being tax deferred means that an individual can invest their assets within the account with no tax implication until withdrawal. Interest, dividends, and capital gains are not recognized on investments held inside these retirement accounts. Generally, contributions to qualified retirement accounts have the additional benefit of being deductible against your income taxes for the year of contribution. This allows for more dollars to be exposed to the market and benefit from the compounding effect of capital appreciation. However, when you withdraw money from a retirement account, the money withdrawn is then taxed.
This brings us to a popular classification of retirement accounts: ROTH accounts. A ROTH account is funded by money on which an individual has already paid income tax. This money can then be invested inside the ROTH and receive the same tax deferred treatment as a traditional retirement account. Since the account is funded with after-tax money, the main benefit is that money withdrawn in retirement is not included in taxable income which means that any investment gain is effectively tax free.
There is another type of investment account that few individuals see as a retirement account: Health Savings Accounts. While not specifically a retirement account, HSAs are available to individuals with high-deductible health insurance classified as a High Deductible Health Plan (HDHP). For 2022, health insurance may qualify as a HDHP if your deductible is at least $1,400 and your out-of-pocket annual expense is capped at $7,000 ($2,800 deductible and $14,000 cap for family coverage). If your health insurance qualifies you to be able to open and fund an HSA, the money you invest into your HSA is unique in one regard: You may never have to pay tax on that money! When you put money into an HSA (contributions limited to $3,650 for individual plus $1,000 if you are 50 and $7,300 plus $1,000 if you are 50 for family coverage in 2022), that money is treated as though you are funding a traditional retirement account and not included in your taxable income. Additionally, when you withdraw money from your HSA to cover qualified medical expenses the money withdrawn is treated like a ROTH account and not included in your taxable income. In short, HSAs combine the tax benefits of both traditional and ROTH retirement accounts with neither of their drawbacks.
Another big benefit of HSA’s is you can reimburse yourself later in life for out-of-pocket medical expenses you pay today. If you have the means to pay your medical expenses out-of-pocket instead of using HSA funds, and keep a record of your out-of-pocket costs, then when you need money later in life (for any reason) you can reimburse yourself out of your HSA to generate funds without tax consequences. If you end up not reimbursing yourself, you still benefit by allowing your HSA to grow through extending the invested life of those assets, and you can always use HSA funds to pay for qualified medical expenses in retirement. Expenses that qualify for tax-free withdrawal from an HSA include Medicare premiums, dental treatments, eyeglasses, medical co-pays, long-term care services, and many others. If you’re interested in the full list of qualified medical expenses, the IRS explains what is and isn’t qualified in Publication 502.
Written May 2nd, 2022
By John W Bowen
As always, please consult a tax professional to analyze your personal situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Information contained herein is subject to change and is considered accurate on date of publication. We are under no obligation to update this post to reflect future changes.