Health insurance and planning for inevitable expenses in the future is a fundamental part of any financial plan. One tool millennials should be taking advantage of, if available to them, is health savings account or HSA as they’re referred to. The benefits of an HSA extend beyond their TRIPLE tax-advantaged status, to the ability to invest funds in the account, and for it to act as a shadow IRA. This article will explore the benefits of HSAs, why Millennials should be taking advantage and a glimpse of what to expect into the future as healthcare expenses continue to rise.
Prerequisite to an HSA
First and foremost, it’s important to understand who actually qualifies for an HSA. To be eligible you must be currently enrolled in a high-deductible health insurance plan. In 2018, that equates to a deductible of greater than $1,350 for an individual and $2,700 for a family. You may end up paying more out of pocket for medical expenses, but the tax benefits will likely outweigh the additional amount you pay for the deductible.
You’re also allowed to contribute for 2018 up to $3,450 for individuals or $6,900 for families. If you’re in the 24% tax bracket and make the maximum contribution, that saves $828 in taxes for the year, which likely equates to what a lower deductible plan would cost after you deduct the savings from the high deductible plan. Plus, this is before you factor in the added benefits an HSA actually provides!
Benefits of an HSA
HSA’s are Triple Tax-Advantaged
What does triple tax-advantaged even mean? For perspective, 401(k)’s and IRA’s are double tax-advantaged accounts. When you make a contribution to a 401(k) or IRA, you get the tax-benefit of deferring income tax on that money until withdrawals are made in the future. Secondly, the money inside a 401(K) and IRA is invested and defers paying taxes on dividends, capital gains, and interest. The deferral of taxes inevitably results in a greater return than if the funds were invested in a taxable account which has to pay taxes in the year dividends, capital gains, and interest are realized.
Read here for more on the importance of tax-efficient investing.
HSA’s have both of these tax benefits plus one more: the funds can also be withdrawn tax-free for qualified medical expenses. Even if you didn’t plan on investing the funds in an HSA and depleted the account each year for medical expenses, you’re still using funds that never get taxed! There isn’t another account currently available with the tax-benefits HSA’s are given, and Millennials should be taking advantage of this fact.
Admittedly, I can’t take credit for naming it a “shadow IRA”, as a simple google search show’s the wall street journal wrote an article referencing the name in 2014. The name references the ability of an HSA to act as a supplementary retirement account that mimics an IRA once the account owner reaches age 65.
Unlike the HSA’s cousin account, the flexible spending account (FSA), HSA’s don’t have a “use it or lose it” stipulation. Meaning, funds contributed that aren’t used for medical expenses in the same year can simply remain in the account for future use.
Not only can the funds be used for future medical expenses, once the account owner reaches age 65, it effectively becomes an IRA where funds can be used for anything without paying a penalty! For example, if an HSA owner withdrew funds prior to age 65 for anything other than medical expenses, they would owe ordinary income tax plus a 10% penalty on the withdrawn funds. However, upon age 65, withdrawals are only subject to ordinary income tax, exactly as if it were an IRA.
HSA Strategy for Millennials
You’re probably thinking, why should I care? I’m not even close to 65! Bare with me here. There’s still one last benefit to cover in regards to HSA’s that rounds out our strategy. They allow you to invest the funds you contribute, meaning you can benefit from decades of compounding in another tax-advantaged account in addition to your retirement accounts. Rather than leaving the funds in cash, in which they’ll actually lose value due to inflation, be sure to invest the funds in your HSA.
To get the most value out of your HSA, if you’re a healthy individual, consider maxing out your contributions each year, and using cash out of pocket to pay for medical expenses as long as they fall within your deductible. This will allow you to accumulate funds to invest in the HSA. Because the HSA doubles as another retirement account, you can’t go wrong.
In fact, it can be argued HSA’s should actually be “maxed out” prior to other retirement accounts, due to the fact they can act as a retirement account AND a healthcare expense account.
Why You Should Open an HSA if Eligible
The estimated cost of healthcare expenses in retirement for an individual retiring today is roughly 189k for men and 214k for women. Retirees and near-retirees are burdened with exploding healthcare expenses. If we can expect more of the same when our time comes, we’d better be prepared, and HSA’s are currently the best way to hedge our risk of outliving our money due to inflating healthcare expenses which we’ll all inevitably face as we grow older, and our health deteriorates.
Unless of course, you’re banking on some sort of Altered Carbon future (highly recommend if you’re into sci-fi dystopian future shows!). In which, case you still have to be unbelievably rich to have eternal life…
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Levi is the Co-Founder, Financial Planner of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!