25 Feb The Power of the HSA!

The H.S.A. has been mentioned in at least two different posts and it’s time to do this tool the justice it deserves.  If you have access to an H.S.A., not to be confused with an F.S.A, then this post is for you.  I’m not a CFP or CPA, so please consult with yours to ensure you are getting the most up to date information that is most accurate to you.  I believe this might be potentially the most powerful investment tool some have access to right after the match on your 401k.  There’s not an argument one could make that would tell me anything is better than the employer match doubling your money, but the H.S.A. I can see from multiple angles.  While this is a great tool, not everyone is going to have access to it because you have to be on a qualified health insurance plan in order to open and contribute to this account.  Typically, you need to be on a high deductible health insurance plan, and it state you are eligible to participate.

I was on a high deductible health insurance plan from 2008-2010, and then again from 2012 or 2014 until mid-2020.  As I’ve mentioned before, I sadly didn’t understand the power of this tool and either didn’t fund it or vastly underfunded it.  It was underfunded not because I had medical expenses I could have used it for, but because it is possibly the best retirement tool you can invest in right after the 401k match.  Here’s how the H.S.A. fundamentals work and a roadmap for this post:

• Open an H.S.A. at a bank of your choosing, shop around because they don’t all offer an investing component
• Notify your employer that you wish to contribute to an H.S.A.
• Your employer automatically puts in the amount you request each paycheck pre-tax
• You keep some portion of your H.S.A. in cash, and consider investing another portion, your choice
• You let it grow
• You use it when you need it for medical expenses that you CAN’T pay in cash from a regular checking account
• You use it when you want throughout life tax free as long as you have medical receipts that are qualified and were paid in regular cash or non-H.S.A. checking accounts
• You hold onto it until retirement and use it for qualified medical expenses tax free
• You can use it in retirement for non-medical expenses with tax but no penalty

If you have a high deductible insurance plan, I would absolutely consider this as a potential piece to your short and long-term savings plan.  You can go to your bank to get an H.S.A. in most cases but you need to be sure it has the option to invest it in index funds.  Many banks will offer this feature but they may have limited funds you are able to invest in, so make sure you get a list of what you could be investing in to do your research and ensure they meet your risk tolerance levels, long term goals, and that the fees/expense ratios are low.  Another piece to consider when shopping around is the minimum balance you must keep in cash before you can choose to invest future dollars.  In some cases you may want to keep more in cash anyway for your own peace of mind, but if you are of the more aggressive mindset like myself, we keep the minimum $1,000 in cash and the rest is invested in index funds.

Once you’ve opened your H.S.A. it should be a fairly simple process to notify your employer that you have one and set up the amount you want to contribute.  If you are set up like I am and get paid every other week, I took the total annual contribution limit and divided by twenty-six (26 paychecks a year) and that automatically went into my H.S.A. Pre-tax.  While you can contribute to an H.S.A. later on out of your regular checking or savings account and still receive a tax deduction when you file your taxes, you avoid all payroll taxes as well when you do it pre-tax via your employer.  So if you can, do it.

Once you’ve set up your H.S.A. to be deducted it will automatically fund your cash account first and then start automatically sweeping any excess funds above that threshold into investments of your choice.  In my personal case I have 90% of my money going into a total S&P 500 index fund with an expense ratio of .07%, and the remaining 10% of my contributions going into a bond market index fund with an expense ratio of .07%.

As you find yourself purchasing items that would qualify for an H.S.A. such as prescriptions, certain over the counter medications and potentially other items you’ll have a choice to make.  You can pay from your H.S.A. debit card, or your personal account and save that receipt filed away forever, this is critical.  This is the step I didn’t learn until 2019 and wished I had learned far sooner.  Instead of using our H.S.A. for chiropractor visits or random doctor bills we might have, we pay cash out of our regular checking account.  We take the receipt, take note of the last four digits of the card it was paid on, note on the receipt “Not H.S.A. Payment” with a date, and then we photocopy the receipt and staple it to the photocopy.  If you’ve ever kept a receipt for longer than a couple years, you’ll see that ink fade, we need that ink because it’s part of the power of this account.  So, why would we pay out of pocket for medical expenses when we have this account that is setup pre-tax for just such a need as medical? The answer is because we can pay cash now, allow the H.S.A. to go in pre-tax, grow tax free, and then be withdrawn tax free at ANY time in the future up to the amount of the receipts in that special file we just talked about.  If this were a podcast, I’d tell you to hit the rewind fifteen seconds button a couple times and re-listen to this section again, but this is a blog so just go back a few sentences and read that again and I’ll follow up here with an example.

Let’s say you’ve maxed out your H.S.A. for a few years and the maximum family contribution is $7,200 a year (it tends to grow each year, but we’ll keep it simple), you have $21,600 plus or minus any investment gains or losses that you’ve incurred while your money is invested.  From there you are in a situation like me where I’m now on a traditional health care plan through my wife’s employer so we can no longer contribute to an H.S.A.  The upside is my premiums cut in half, the down side is I no longer have access to fund my favorite tool right after the 401k match.  In any case, let’s say ten years from now that money has grown an average of 7% with me not putting in another penny.  This account should now be worth approximately $43,408.69 cents, we’ve more than doubled our money, yay! Here’s where it gets fun, let’s say you are retired early or heck you aren’t retired early but you want to take a vacation but your money is locked up in this H.S.A. and other retirement accounts, or perhaps you are just on a fixed income and don’t want to tap your regular funds.  Over the time you were contributing to the H.S.A. you kept receipts for medical expenses you paid cash for, grab as many receipts as you need to total up the amount of money you want for the vacation or whatever your item of choice is, send them to your CPA and say you want to pull X amount of dollars from your H.S.A. account and these are the receipts I want to reconcile against it, paying myself back for great decisions a decade ago.  You cool with that bro? And they’ll likely tell you to go for it!  I’m not a CPA so make sure you talk with yours regarding this strategy, but I’ve cleared it with mine and it is part of why I love this tool so much.

Alternatively you could simply leave the money in your H.S.A. and let it grow and grow until you reach the qualified retirement age at which point you can either spend the money completely tax free (went in pre-payroll tax and tax free ) on medical expenses and some specific Medicare premiums or you can take it out as income for non-medical expenses however it WILL be taxed in the same manner you would be taxed on a traditional IRA.  This is still a powerful option because hopefully you’ve done a combination of 401k investing, Roth or traditional IRA funding, and now you have this additional pre-tax tool that acts just like an IRA.  Let’s be real though, when we’re at traditional retirement age we are going to have medical expenses, so chances are you’ll be swiping that H.S.A. debit card for some transactions which you’ve officially began to fund your traditional retirement age years medical spending 100% tax free.  That is something I can get on board with.

As I wrap this thing up, I once again want to state two things; First, this only works with an H.S.A., do not confuse this with an F.S.A. which has minor benefits, but you really need to know what you are doing to avoid losing F.S.A. dollars.  Second, make sure you talk with your CPA to ensure you understand this type of planning fully and they are on board with it.

If you can’t tell, I love the H.S.A. and really wish I’d understood it in all of the years I’d had access, had I fully funded that account back then when I had access where would I be today, you ask? Well my balance today would be in the ballpark of $50-60,000 but because I underfunded it, and additionally spent it on qualified medical expenses along the way it has just $15,000 in it today.   I guess it’s an expensive lesson learned and by the time I learned it I couldn’t fill it fast enough and then a “good problem to have” arose and it made sense and a huge savings to move over to a traditional health care plan for the foreseeable future.