The HSA Trifecta: Why I think the HSA account is the Post Malone of retirement savings accounts
Post Malone (the entertainer trifecta):
1. can belt out a tune in just about any genre 2. exudes joy and it seems genuine 3. shows kindness and appreciation
First a pitch for automation.
Saving for retirement is challenging. It takes discipline to put money away for future spending needs instead of spending it now. Also, it can be confusing to decide what type of retirement savings account you fund first, second, etc.
I’m going to take the first challenge off the table with one word: automatize. If you need help with the discipline piece of saving for retirement read David Bach’s, The Automatic Millionaire (2003). He drives home the message of “pay yourself first”. Bottom line: set up automatic contributions to your retirement account(s) monthly. Have the money go straight to these accounts before it lands in your checking account. You’ll thank yourself later for putting money to work for you instead of spending it mindlessly.
The second challenge can be trickier: which account to fund first, second, etc. It’s challenging because everyone’s situation is a tad bit different (or a lot bit different).
If we could all max out every opportunity for a tax advantaged savings plan, we wouldn’t need to have this discusssion – just max out all that are available to you. If however you have to make choices as to what type of account you use to invest your savings, I’ll offer some things to think about…
It (pretty much) always makes sense to prioritize a contribution to your 401k (or 403b, etc.) to the extent that your employer matches your contribution. After all, I would never want you to leave that “free” money on the table. However, it might not make sense to fully fund it just yet.
The HSA Trifecta
Whether you agree with my Posty opinions or not, I think you’ll agree an HSA is a retirement plan trifecta:
1. pre-tax (or tax deductible) contributions 2. tax-deferred growth 3. tax-free distributions for qualified medical expenses
Oh, wait! It’s even better than a trifecta!: 4. at age 65 you can start using it like another IRA/401k type account as you can take distributions for any purpose (but you will pay ordinary tax on the distribution).
If you have a HDHP (high-deductible health plan) contributing to your HSA (health savings account) next likely makes the most sense. In order to contribute to an HSA, you have to be enrolled in a HDHP. For calendar year 2024, a “high deductible health plan” is defined under §223(c)(2)(A) as a health plan with an annual deductible that is not less than $1,600 for self-only coverage or $3,200 for family coverage, and for which the annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $8,050 for self-only coverage or $16,100 for family coverage.
Why an HSA instead of putting more into your 401k or contributing to a Roth IRA?
All these retirement savings plans have tax benefits. They all offer tax-deferred growth and either pre-tax (tax-deferred) contributions (IRA, 401k, 403b) or they offer tax-free distributions (Roth IRA). The HSA, however, offers a triple tax bonus: pre-tax contributions, tax-deferred growth, and tax-free distributions when those distributions are to cover qualified medical expenses.
It doesn’t stop there! Any distribution you take from an HSA account that is not for qualified medical expenses when you are under the age of 65 comes with a stiff 20% penalty (ouch!). But, once you turn 65 that HSA account becomes, for all intents and purposes, an IRA/HSA account. That’s because when you turn 65 you no longer pay a penalty to take funds out for non-medical purposes. You can still can take tax-free withdrawals when there is a qualifying medical expense tied to it, though. Added bonus: you don’t have to take RMDs (Required Minimum Distributions from an HSA account when you turn RMD age which is currently 73 years old).
Are you a “high-income earner”? There are income limits on how much you can contribute to a Roth IRA. There are no income limits to contribute to an HSA and it lowers your taxable income for that year! If you don’t need to utilize your HSA funds for medical expenses (I’d even go so far as to suggest you don’t use those funds unless you have to) those dollars go to work for you toward your retirement. They sit in that account enjoying tax-deferred growth until you need them to pay for qualified medical expenses or to fund your retirement after age 59.5.
This is a solid choice for anyone with an HDHP. If your income is above the threshold for contributing to an IRA or Roth IRA it’s a no brainer.
OK, so then what?
For calendar year 2024, the annual limitation on deductions under §223(b)(2)(A) for an individual with self-only coverage under a high deductible health plan is $4,150. For calendar year 2024, the annual limitation on deductions under §223(b)(2)(B) for an individual with family coverage under a high deductible health plan is $8,300. Your employer can contribute up to$2,100 of that for you if they choose to.Maxed out your HSA? Now analyze making bigger contributions to your 401k or Roth 401k or to a Roth IRA etc.
Word to the wise about an HSA…
Does the HSA account your employer provides have the ability to invest those funds in the market? If not you need to check into your options. Some employers will let you roll those HSA funds into a different HSA account. An HSA account set up with a custodian (Fidelity for instance) will allow you to invest those dollars in the market. After all, its difficult to enjoy tax-deferred growth if the funds aren’t growing.
Also noteworthy: contributions made to your HSA by your employer and contributions you make in a cafeteria plan through your employer’s payroll do not count toward gross income. If you make any contributions outside of payroll you can deduct them. This will be an above the line deduction so you can take it whether you itemize or not. If you aren’t sure what an above the line deduction is, you can watch this video where I explain this and other key income tax concepts: https://youtu.be/Yo22sOJcv6k?si=FAz1wZIYq2WkiE7c
As I’ve alluded to, everyone’s circumstances are different, and these general guidelines may not apply to your financial situation. You’ll need to look at all aspects of your financial life to determine what is best for you.
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