If you live in the U.S. and have a High Deductible Health Plan (generally any health plan with a deductible of at least $1,350) then you likely have access to a Health Savings Account (HSA).
In this article, I’m going to make it very clear why you should take advantage of an HSA and why it’s perhaps the best wealth generating vehicle.
First, what is an HSA?
An HSA is a type of savings account that lets you set aside money on a pre-tax basis to pay for qualified medical expenses. By using untaxed dollars in an HSA to pay for deductibles, copayments, coinsurance, and some other expenses, you can lower your overall health care costs.
For 2019, you can contribute up to $3,500 for self-only coverage and up to $7,000 for family coverage. HSA funds roll over year to year if you don’t spend them. An HSA may earn interest, which is not taxable.
Now in more plain English
Any income that you make that you deposit into your HSA will go in before taxes. This is basically the only money you’ll ever make that Uncle Sam won’t take his cut.
This money will also roll over, year over year. Unlike a Flex Spending Account, an HSA is not “use it or lose it.” If you come to the end of the year with money in your account, it’ll roll over to the subsequent year.
And the best part of an HSA, you can actually invest the money in your HSA in the stock market. Once you need to take the money out, you can also pull it out, TAX-FREE.
“So let me get this right…”
“You’re telling me that I earn the money, invest the money, and withdraw the money (including the investment growth) without paying taxes?”
“Why would the government allow this?”
The government knows that healthcare costs are out of hand, so this is their way of trying to help us manage the cost of healthcare.
Now onto the wealth-generating strategy
The reason why the government offered up the HSA, to begin with, is because they know the average American is broke and can’t afford to cover even a $400 surprise expense.
If you’re reading this article, then I’ll make a basic assumption that you are not living paycheck-to-paycheck, and you’re on the path to financial independence. If that’s the case, then I’m going to start by giving you this advice for your HSA:
DON’T USE IT
And what I mean by that is, if you max out your HSA contributions every year, you’ll quickly amass thousands of dollars in your HSA. At some point, you’ll naturally have some pricing healthcare cost, and my advice is to keep your HSA balance intact and pay for any expenses not covered by your insurance out of pocket.
“So you’re telling me, the government gave me this awesome account to help minimize healthcare expenses and you’re telling me not to use when expenses arise?”
Yes, and here’s why.
In the table below, I’ll show you what $5,000 would look like if invested in an:
- HSA – (never taxed)
- Traditional 401k – (taxed as income when you withdraw the money)
- Roth IRA – (taxed as income prior to investing)
- Brokerage Account – (taxed as income up front and the gains are taxed when you withdraw the money).
(I know that there is more nuance to these accounts and there are penalties to pulling money out of a 401k and IRA if you aren’t of retirement age, but we’re just going to keep things simple and basic to make this example clear)
Hopefully, the chart above makes it obvious just how awesome the HSA is. By investing the money in your HSA and letting it grow for years, you can end up with a very healthy sum of money that outperforms 401ks, IRAs, and Brokerage Accounts.
Now you’re probably wondering, “so when do I use the money in my HSA?”
Like most things in personal finance, this is a judgment call that only you can make. My general guidance is to hold off as long as possible as healthcare costs only go up as we increase in age.
But, there is another nice provision that makes the HSA even cooler and easier to use when you need the money.
Let’s say that you have a baby in 2020 and it costs you $5k. You decided to pay out of pocket instead of using your HSA.
Fast forward to 2035, and you’re a little strapped for cash. You had some surprise expenses and you need cash to buy a house. Lucky for you, you saved all of your receipts from your baby birth all the way back in 2020. Now you can go ahead and pull out the money for an expense all the way back in 2020, 15 years earlier.
Since you let that money sit in the market for 15 more years it has grown so you could pay for 4 births instead of the 1, had you used the money in 2020.
To reiterate my recommendation for your HSA:
- Hold off on using the money for as long as possible and let your HSA grow
- Save your receipts for health-related expenses. Perhaps everything over $250 to make things easy, but the amount is up to you.
- Enjoy watching your cash grow tax-free to set you up for success