Become an HSA (Health Savings Account) Millionaire!

A Health Savings Account is like a 401(k)-type plan on steroids.

In last month’s newsletter (5 Tenets of Successful Stock Investing), I called a quality 401(k)-type plan with a match the “best wealth-building account on the planet.” I stand by that statement because of 401(k)-type plans high contribution limits. An HSA, however, will give you a better after-tax return (everything else being equal).

Don’t enter your HSA and 401k in a boxing match, as depicted by the silly AI-generated picture above. Have them work as a team and kick that financial independence or retirement goal’s ass!

An HSA is the world champion when it comes to tax breaks. When you invest in an HSA, you get 4 of them, more than any other tax-advantaged account.

A Quadruple Tax Break!

1. Tax Deduction on Contributions – Money contributed to your HSA is not taxed, reducing your tax bill each year you contribute. This deduction benefits all savers but especially higher-wage earners who stand to save the most in taxes.

2. Tax-Free Distribution of Contributions – Unlike traditional contributions, which are taxed when you take them out, your principal is tax-free when withdrawn.

3. Tax-Free Distribution of Earnings – All earnings (interest, dividends, and capital gains) accrue tax-free in an HSA. Earnings are not taxed upon qualified withdrawal.

4. No Payroll Tax Deducted on Contributions – You only get this deduction when funding an HSA through your employer but don’t overlook how much it saves. Payroll tax consists of both Medicare (1.45%) and Social Security (6.2%) tax. Note that payroll taxes are deducted when making a 401(k)-type plan contribution.

With pre-tax contributions to a 401(k)-type plan or traditional IRA, you enjoy #1, with Roth contributions to a 401(k)-type plan or Roth IRA you get #3. With an HSA, you get all 4! Add an investment plan tailored to your risk tolerance and time horizon and you too can be an HSA millionaire.

Saving and Investing in Your HSA

My millionaire strategy is simple: Save and invest the maximum HSA contribution limit between now and age 65. Prioritize funding your HSA each year and try not to withdraw any of it until later.

Back in 2003, I’m sure the sponsors of the HSA didn’t have this millionaire strategy in mind when it passed through Congress and was signed into law. They didn’t realize they created the most powerful wealth-building tool on the planet.

Despite this strategy becoming more popular, many employer-sponsored HSAs still don’t offer investment options in their accounts. Or their investment options have bloated expenses and high fees. Don’t let that sway you from adopting this strategy.

Once funds are deposited into your employer’s HSA, including any employer match, transfer it to a quality HSA with investments that offer efficient and low-cost indexed ETFs and mutual funds, like the one at Fidelity Investments®.

Save Your Medical Receipts

Question: What’s the time limit for reimbursing yourself from your HSA for an unreimbursed medical expense? Answer: There is no time limit. Your medical receipts act as tickets to future tax-free HSA withdrawals.

Electronic storage of your medical receipts is a must because you may be saving medical receipts for 1, 5, 10, or 20-plus years. Cheap paper receipts don’t last that long. The IRS is cool with electronic copies. It’s as easy as taking a picture.

Qualified Withdrawals

Money withdrawn from your HSA must be considered “qualified” to be tax-free. Both current and past unreimbursed medical expenses are qualified. So are a lot of over-the-counter medications. The IRS maintains a complete list of qualified expenses at https://www.irs.gov/pub/irs-pdf/p502.pdf.

Once you reach 65 and enroll in Medicare, you can no longer contribute to an HSA. You can, however, tap your HSA tax-free to reimburse yourself for payment of Medicare premiums for you and your spouse, which in 2024 is over $4,000.

Your HSA can save the day if you or your spouse require long-term care, and an HSA can be a suitable substitute for expensive long-term care insurance. Medicare only covers a fraction of long-term care expenses.

What if you end up having it all: Good looks and good health? Once you’re 65 or older, you can withdraw HSA funds without the nasty 20% penalty for non-healthcare-related expenses, but you do have to pay tax on it (much like traditional contributions).

Millionaire Examples

Not for Everyone

Are you fired up to become an HSA millionaire? Not so fast. Before committing to the plan, consider the possible downsides. It depends on you and your family’s healthcare options and needs.

Whether you have employer-sponsored health insurance, private insurance, or you get it through the exchanges, it can be incredibly confusing when mulling your options. Choosing the right healthcare is an important decision, so make sure you read the literature.

Make the right choice for you and your family. And remember, you can always switch back to your old plan next year if things don’t work out.

High Deductible Health Plan

With a high deductible health plan, you’ll pay more out-of-pocket for healthcare when you use it than with a lower deductible plan. However, high deductible plans have the lowest premium and the right to contribute to an HSA.

Are you and your family “heavy users” of health insurance? If yes, think twice about signing up for the high-deductible plan, despite the value of an HSA. A lower deductible plan could save you a lot of money. If an FSA is available, you can save even more.

The HSA millionaire strategy is at its best if you rarely use your healthcare. Additionally, you must be willing to delay withdrawing money from your HSA and pay all your medical bills out-of-pocket.

Flexible Savings Account (FSA)

Don’t discount the value of a flexible savings account (FSA), especially if a high deductible health plan is not for you. Just like contributions to an HSA are tax-free, so are contributions to your FSA. Just be sure you don’t fund it with too much money.

Do some research and find out what your medical expenses were last year. Then you can more accurately predict what they’ll be for the coming year. FSAs are “use it or lose it”: Unlike an HSA, only a small amount can legally roll forward for use in future years.

If your employer offers both HSAs and FSAs, most HSA contributors can still use what employers call a limited-use FSA, which is for vision and dental expenses only.

What to Use Instead

If you’re not destined to be an HSA Millionaire, don’t fret. There are plenty of other great tax-advantaged accounts you can use to build your wealth instead. I love a quality 401(k)-type plan, especially if it has a match, and Roth IRAs and 529s too.

Find out more about these alternatives. Download my best-selling e-book A Beginners Guide to Roth IRAs and 401(k)-Type Plans. Or purchase the paperback. Just click or tap on the title. The link takes you to Amazon® for a hassle-free download in the format of your choice. Do it now because it’s free for today only (June 21, 2024).