Taking advantage of the ability to invest our money before paying taxes on it is absolutely
genius.
It allows us to invest more of our own money and do it earlier on then we would have been
able to otherwise and because of the miracle of compounding interest that means our money
could grow to exponential levels by the time we reach retirement.
The only issue with this strategy and it is a minor one mind you, is that the government
puts limits on how much money we are able to invest pre-tax.
Now like I said it is a minor issue because after all, big picture, it's great that we
have the ability to do it at all, but wouldn't it be nice if we could do it more?
Or if we just have more options than the IRA or individual retirement account and possibly
a 401k if your company has one?
I certainly think so and thankfully there are some options that are actually out there
for us that not enough people are taking full advantage of, and that's exactly what I'm
going to talk about today.
Today I'm going to be discussing why I consider the HSA or the health savings account to be
one of the most underrated retirement superweapons.
Hey everyone Daniel here and welcome to Next Level Life a channel where you can learn about
Investing, debt, retirement, and many other general financial education videos because
the school's aren't going to do it for us.
So if any of those topics sound interesting to you or if you want to learn how to better
handle your money and have more financial freedom be sure to hit that subscribe button
and the bell next to my name to be notified every time I upload a video.
And if you want to further support the growth of this channel you can check out some of
the links I’ve left down in the description below which includes a 30-day free trial of
Audible and 2 free audiobooks of your choice as well as a list of some books on money I’d
recommend checking out, or you can share this video with a friend, and leave a comment below
letting me know what topics you’d like me to cover in future videos.
So today we're going to be talking about the HSA because after reading several articles
in Forbes, on the mad fientist’s blog, and from other sources talking about the HSA as
a potential retirement savings vehicle, I felt inspired to make this video and help
get the word out there even more.
But before I get started I feel obligated to say that this video may not apply to everybody,
but for those who are eligible to take advantage of the HSA, in other words, those of you who
are on or will be on a high deductible health plan, I believe it is one of the most underutilized
and dare I say underrated retirement accounts.
With that in mind, we're going to be talking about the features of the HSA in comparison
to a Tradition and ROTH IRA as well as how to take advantage of the HSA as a retiree
or even an early retiree as well as some potential advantages and pitfalls to keep in mind.
Let's get started.
So unless you have a 401K where you work the most common forms of retirement accounts for
most people are the traditional and Roth IRAs.
The traditional IRA allows you to contribute a certain amount of money each year, $6,000
in the case of 2019, before paying taxes on it to fund your future retirement.
The money is then taxed when you withdraw in retirement.
A ROTH IRA takes the opposite approach, allowing you to contribute a certain amount of money
each year after it has been taxed, again $6,000 in 2019, but it is then allowed to be withdrawn
tax-free when you reach retirement.
However, one of the biggest fears that many retirees and early retirees alike have that
neither of these accounts adequately address, at least directly, is that they won't be able
to cover the cost of healthcare when they retire.
Healthcare costs have been rising quite rapidly over the past several years in the form of
higher insurance premiums, the cost of doctor visits, or long-term care so you can understand
where hopeful retirees are coming from... that stuff can get quite expensive in worst-case
scenarios and, if not planned for properly, can be budget breaking even in less than worst-case
scenarios.
And let’s face it, while you could withdraw money from a traditional IRA you’d get hit
with taxes and, depending on when you withdraw the money possibly a penalty for early withdrawals
as well, which would make it a less than ideal move.
The ROTH is a little bit better since you can at least withdraw your own after-tax contributions
to help pay for things without having to pay the 10% imposed on the traditional IRA early
withdrawals on top of that but since it was after-tax contributions that went into the
ROTH in the first place, you may be pulling out of a smaller pond than you would have
if the money went in pre-tax.
And that’s not to mention the fact that the money you take out can no longer experience
that tax-free growth in the future which is the biggest draw of contributing to a ROTH
IRA or ROTH anything for that matter in the first place.
In this regard, the HSA is probably the best of the three options to help us prepare for
this potential issue because the HSA allows us to save money pre-tax, allows it to grow
tax-deferred similar to a traditional IRA, and take it out without paying taxes if it
is for a qualifying medical expense which is similar treatment to a ROTH IRA.
So it has a potential triple tax benefit by allowing you to save and spend money without
paying any taxes whatsoever assuming it's for qualifying medical expenses.
In other words, you basically get the best parts of the traditional and ROTH IRAs in
one account.
However, as sweet as that is, that on its own would not put it in the class of potentially
the most underutilized or underrated retirement asset in my book.
No the thing that some people I think miss that puts it at that level for me is the fact
that you don't necessarily have to withdraw this money for medical expenses when you pay
them, or potentially even at all.
Let me explain.
Say John starts investing as much money as he can into an HSA account this year.
The maximum contribution you can put into an HSA account every year as of 2019 is $3,500
per year assuming you're an individual and under the age of 55, if you're over the age
of 55 it's actually $4,500 per year thanks to the $1,000 catch-up contribution and families
can contribute up to $7,000 per year.
For the sake of this example let's say John is single and 25 years old meaning that he
would be able to contribute $3,500 per year into his HSA account for those five years
earning an average of 8% per year on his investments.
That would mean that he would have accumulated a little over $22,000 in his HSA account by
the time he was 30.
Then say he has a qualifying medical expense that will cost him $1,000.
And if you want to see what qualifies as a medical expense I’ve left links to the IRS
and HSA Bank websites that go into all that information.
Now ordinarily John would take some money out of his HSA account to pay for these medical
expenses after all that's what the HSA account is supposed to be used for.
However, he doesn't actually have to right away.
Assuming he has enough money saved he is allowed to pay for that medical expense out-of-pocket
just like anyone without an HSA account would do.
And in doing so he would allow himself to let his pre-tax investment into his HSA account
continue to grow tax-deferred, if not tax-free again depending on what he eventually uses
the money for.
If you look at the laws surrounding the HSA distributions there is currently no law saying
that you have to directly pay for the qualifying medical expense with money from your HSA account
as I just said, but there's also not a rule stating how long you can wait to take a distribution
for a qualifying medical expense.
According to the HSA Bank’s website, assuming the medical expense occurred after you opened
the HSA account you could, theoretically, wait years to reimburse yourself for your
qualified medical expense with a tax-free distribution from your HSA, though they do
note that you will want to keep your receipts for your records in case the IRS ever decides
to audit you.
In John's case, he could take a distribution from his HSA account and use it to pay for
that qualifying $1,000 medical expense with tax-free money as soon as he received the
bill.
He's got the money in the HSA account, it is a qualifying medical expense, he's allowed
to do that, or he could delay his HSA distribution until he reaches retirement which depending
on when he retires could be years down the line.
But since the distribution is to reimburse himself for a qualified medical expense that
he can prove was incurred after he already opened his HSA account that $1,000 would come
to him tax-free.
Now the other question that'll come up is well what if I don't have any qualifying medical
expenses?
Well first of all that's probably the best case scenario to be honest if you go all the
way to retirement and you don't have any qualifying medical expenses that probably means you lived
a pretty healthy life and honestly that's a heck of a lot more important but if you
are fortunate enough to go all the way to retirement or whenever you plan to withdraw
the money without having any qualified medical expenses the HSA effectively turns into a
traditional IRA of sorts.
Again according to the HSA Bank’s website, under current laws, you would be able to withdraw
your money for any purpose, whether medically-related or not, after you reach the age of 65.
So it's very similar to a traditional IRA in that sense because you are going to have
to pay taxes on the money that you would withdraw assuming it is not for a qualifying medical
expense.
The main difference is that you have to wait until the age of 65 instead of 59 and 1/2
like in an IRA which could be a bit of a drawback if it is your only retirement savings account,
but obviously it shouldn’t be.
But the fact that it basically functions as a traditional IRA after you turn 65 is also
what makes this a retirement planning superweapon.
Let’s look back at John’s example.
He was able to invest $3,500 per year into his HSA, even if he retired early at 40 years
old and stopped contributing at that point he would end up with over $700,000 by the
time he is 65 and able to start using the money in the HSA as a more traditional retirement
account.
That’s $700,000 in addition to anything he may have put in an IRA or 401K as well
as whatever he may have in his taxable accounts or whatever he may be making through retirement
side-hustles and other passion projects.
The numbers would, of course, continue to become more impressive the later he stopped
contributing.
If he didn’t stop contributing until the age of 50, for instance, either because he
worked longer than before or because he had some passive income streams or revenue from
side-hustles that left him enough money to continue funding accounts like his HSA he
would end up with over $875,000!
And if he continued contributing until he reached the age of 65 he would’ve earned
himself nearly $1 million in addition to his other savings.
Even if he didn’t have anything else at that point it still may be enough to fund
a LeanFIRE lifestyle in retirement from age 65 onward.
So if you are already on a high deductible health plan and are eligible for an HSA, I’d
suggest looking into it with a tax professional and your financial advisor, you may be glad
you did.
While it may not be for everybody (don’t just switch to a high deductible health plan
to take advantage of it without looking at the other potential factors like potential
costs of being on such a plan if you regularly incur lots of medical expenses) it can be
yet another great tool to have in your financial toolbelt.
Not to mention the fact that the money in an HSA account can be taken out tax-free for
things like Medicare expenses in many cases, so it may well prove to be of use to you way
down the road of retirement.
But that'll do it for me today once again if you enjoyed this video be sure to subscribe
and hit that Bell next to my name so that you'll be notified of all my future uploads.
I generally upload every single Monday, and if you have a friend that would be interested
in this kind of content be sure to share it with them and let's really get this information
out there and start our own Financial revolution.