The Best Investment You’ve Never Heard Of

Would you be interested in an investment vehicle where your contributions go in pre-tax, they grow tax deferred and when you take the money out it’s also tax free?  If you’re thinking, this sounds “too good to be true,” then let me share a tax/retirement planning strategy that some savvy investors have been taking advantage of for years.

As health insurance premiums have skyrocketed, both individuals and employers have been looking for ways to reduce costs.  One option that has been gaining in popularity is a high deductible health plan (HDHP).  HDHPs typically come with lower monthly premiums in exchange for higher out of pocket costs/limits.  The real opportunity for investing comes in the form of a Health Savings Account (HSA).  When you enroll in a HDHP, you are eligible to contribute money to an HSA pre-tax; the assumption being that you will use these additional pre-tax dollars to help offset the additional out of pocket costs of the HDHP.  In some cases, employers even encourage enrollment in HDHPs by incentivizing employees with money contributed to an HSA by the company on the employees’ behalf.

The HSA account, unlike a Flexible Spending Account (FSA), does not have a “use it or lose it” provision that forfeits any remaining balance in the account at the end of the year.  Any unused funds in the account are able to be “rolled over” into the next plan year for future medical expenses.  And this is where the opportunity really exists.

In 2021, an individual (including any employer matching) can contribute up to $3,600.   For those with family coverage the limit is $7,200.  The IRS typically increases the limits each year based on inflation.  If you and/or your spouse are over the age of 55, you can each contribute an additional $1,000.  Once you begin contributing to your HSA account, you can invest the money the same way you invest your other retirement or brokerage accounts.  The funds in your HSA can be used, tax free, to pay for medical, dental and vision expenses, long term care premiums and Medicare premiums, just to name a few.

Assuming a 25 year old started investing $3,000 per year in their HSA account—without any withdrawals, assuming an 8% rate of return, they would have over $750,000 in that account when they turned 65.  That’s ¾ of a million dollars to use on medical expenses TAX FREE.  And if you don’t want to spend it on medical costs, you can treat it like a Traditional IRA after age 65 and simply pay taxes on the withdrawals.  Meanwhile, you have enjoyed tax-deferred compounding interest all along the way.

There are a few caveats to this strategy:

• Any dollars withdrawn from your HSA before 65 that are not used to pay allowable expenses are subject to a 20% penalty.
• You must be enrolled in an HDHP to contribute to an HSA.  There are very specific rules if you have not been enrolled in an HDHP for the entire calendar year.
• You can continue to contribute to an HSA after 65 as long as you haven’t enrolled in Medicare.  If you enroll in Medicare, you can no longer contribute to an HSA.
• If you are borrowing money (i.e. carrying balances on credit cards or taking out loans) to pay for medical expenses to avoid using money from your HSA account, you are likely eliminating any of the benefits you will realize with this strategy.

Creating the most tax efficient vehicle available by funding an HSA for future medical expenses continues to be one of my favorite planning techniques.  Although it is not a one-size fits all approach, the significant increases in health insurance premiums and out of pocket costs make this strategy one worth examining on an annual basis with your financial planner.  Even if you aren’t able to maximize the contributions into your HSA each year, or if you have to spend some of the money in the account to help pay for medical expenses, it is still a great tool in your arsenal as you plan for retirement.