By Robert Wilson
Starting in 2019, my wife and I are going to start our journey of becoming millionaires. Many people strive to become millionaires and use retirement accounts to accomplish their goals, but we’re taking a bit of a different path – using our HSA account to our advantage.
Before we get into that, let’s start by looking at the numbers. Today, a 65-year-old couple can expect health care costs of roughly $280,000 over the course of their retirement. Many project the health care inflation rate to be close to 5 percent, so if you plan to retire in 30 years you and your partner might estimate $1,152,518 of health care costs.
While that is definitely a daunting figure, there is a good strategy to prepare for it – that also has a triple tax advantage.
Investing with your HSA
An HSA can be used to complement a high deductible health insurance plan. An HSA is considered triple tax advantaged because you can deposit pre-tax money into it, you can invest it (and it grows tax free), and you can also withdraw funds for health care costs – you guessed it – tax free.
Most people use their HSA to pay the current year’s health expenses, but that’s where our strategy differs: we’re going to pay out-of-pocket for our health care costs and use the HSA as an additional retirement account.
Starting in 2019 the max contribution to an HSA for a family is $7,000, or $3,500 for an individual. If we invest the $7,000 per year from now until we retire in 30 years my wife and I should have $1,151,458 saved – which is fairly close to the expected health care costs for our retirement. That money will be invested into a straight S&P 500 fund where I expect to earn 10 percent, the historical average rate of return over the past 100 years. We will be able to reduce our taxable income by $7,000 a year, saving $2,310 in taxes paid per year (33 percent effective rate).
For those who don’t use an HSA, assuming a 33 percent effective tax rate in retirement means that they will have to withdraw $1,720,176 from their 401(k) or IRA just to cover health care costs. By saving the money in an HSA, you're required to save 67 percent as much to cover the same costs.
Using your HSA
An HSA can be used on health care deductibles, dental care, imaging tests, vision care, office visit co-pays, prescription drugs and insulin, Medicare premiums, a portion of long-term care insurance premiums, hearing aids, wheelchairs/ walkers, in-home nursing care, long-term care services, nursing home fees, and more.
What happens if you don’t need all $1.15m you have saved in your account? You can use HSA funds for whatever you want in retirement; however, if you use them for non-health care related items the account acts like a 401(k) and you’ll owe income taxes on those withdrawals. You can pay yourself back for prior year’s out-of-pocket health expenses (while you had an HSA), so save your receipts!
Read the fine print first
There are a few downsides to this strategy. First, you must have a high deductible plan, which can mean high costs if have any chronic health conditions or major health events. Second, the tax advantages mentioned above are based on federal tax law – while most states follow federal tax law when it comes to HSAs, some states do not. In Alabama, California, and New Jersey, contributions are taxed; in New Hampshire and Tennessee HSA earnings are taxed. The good news is that even if your state taxes HSAs, you’ll still get the federal tax benefits.
This saving and investment plan makes sense for anyone looking for alternative ways to save for retirement and reduce taxable income. We are using our plan as part of our overall retirement strategy, and will continue to invest 20 percent of our taxable income into our SEP IRA. Unexpected costs are a major reason people fail to achieve their financial goals, so by taking advantage of the triple tax advantaged account you can make your money work smarter – and hopefully enjoy a better lifestyle in retirement.
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Robert Wilson is a stay-at home-dad who dabbles in day trading on the side and manages his family’s finances. He’s not a financial guru, just a finance wonk who likes to be as smart as possible with his money.