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One of the key challenges financial planners face is nudging clients to look far off into their own futures. After all, most people are living today, for today, and without as much planning for the future as we might like. But small steps taken early on can lead to big wins for clients!

A great opportunity for change is a Health Savings Account (HSA) paired with a High Deductible Health Plan (HDHP). HSA accounts offer multiple benefits (which I’ll get to…), but firstly, who probably shouldn’t choose a HDHP?

If the view in the image above looks familiar to you, if you’re managing chronic health issues, if you’re expecting high medical expenses in the coming year, planning to have elective surgery or another child, or if you have little or no emergency funds to cover the high maximum out-of-pocket that comes with a HDHP, then most likely you’ll want to skip a HDHP + HSA (at least for the coming year).

On the other hand, if you are healthy and expect to stay that way, what’s so attractive about the HDHP + HSA combination? HSAs offer triple tax benefits: a juicy tax-deduction now, tax-deferred growth on the invested balance, and tax-free withdrawals for qualified medical expenses later on.

Win! Win! Win!

1. Cut taxes today — You can contribute up to $3,850 (2023) / $4,150 (2024) (individual coverage), or up to $7,750 (2023) / 8,300 (2024) (family coverage), and can deduct those amounts from your adjusted gross income (AGI). Starting at age 55, you can then add an additional $1,000 catch-up contribution, with a spouse doing the same in their own separate HSA... That adds up!

   (Perhaps those seem like small numbers to high earners. But remember, contributing $4,150 per year for 20 years and earning 7.5% on that money is $179,714 tax-free! And $359,429 tax-free for a couple making the $8,300 contribution for 20 years and earning 7.5% on their invested HSAs! I don’t know about you, but that’s real money to me for a relatively small sacrifice today. Start sooner, contribute at the beginning of the year rather than the end, add in the age 55 catch-up contributions, compound the account for longer, earn a higher rate of return… and that tax-free pot of gold at the end of your rainbow will be that much bigger...)

   **Note: You can claim the HSA deduction no matter whether your itemize or take the standard deduction!

2. Invest and grow the HSA tax-deferred — These are not the old ‘use-it-or-lose-it’ style FSA accounts. You contribute your money and keep it in the HSA from year to year. But the real ‘win’ is to not treat your HSA like a savings account with the debit card they may provide, but rather to invest it while covering any out-of-pocket qualified medical expenses along the way with idle cash in the bank.

   **Note: Just remember to save those receipts and to track your qualified medical expenses in order to reimburse yourself tax-free (even many years later…).

3. HSA money comes out tax-free — HSA funds can be used for qualified medical expenses, and for Medicare premiums (Part B/C/D typically, but unfortunately not for supplemental Medigap premiums…) once you turn 65 and go on Medicare. They can also be used for qualified LTC premiums… all things you may need, or want to have.

4. Don’t leave free money on the table — Some employers will make partial contributions to your HSA if you elect the HDHP option they offer. Take advantage! And remember you can still personally contribute the remainder up to the IRS maximum HSA limit to “top up” your HSA.

5. HSAs can serve as an extra “retirement” account — What if you don’t end up needing the money for qualified medical expenses? You can withdraw HSA money starting at age of 65, pay taxes on the ordinary income in the same way you would withdrawing money out of a 401(k) or IRA, and use it for any purpose. In that sense, it’s like having a supplemental 401(k) or other qualified retirement account. You will have to recognize distributed HSA money as ordinary income if not used for an approved purpose, but buy a boat if you really want to (not that I’m necessarily recommending that…).

   *Note: If you withdraw HSA funds for non-qualified uses before the age of 65 you will be subject to ordinary income tax plus a 20% penalty (so avoid that!).

6. No income limits — As long as you qualify to contribute to an HSA, you can contribute no matter how much income you earn. For high earners, this is a boon (and especially if tax rates rise in the future)! For low earners, contributing to a HSA lowers your household income even more, potentially helping you qualify for an even greater subsidy on a health insurance exchange.

7. HSAs can serve as de facto emergency funds — While you can use your HSA funds as you go, reimbursing yourself for your qualified medical expenses (such as prescription drugs, doctor’s visits and co-pays, eyeglasses, lab fees, stop-smoking programs, sunscreen, feminine hygiene products, Ibuprofen and much more), you are actually not required to do that. You can save those qualified medical receipts, and choose when you take tax-free distributions for qualified medical expenses from your HSA account. By doing this you’ll be using less tax-efficient dollars in your taxable bank account today to pay for these expenses, while keeping tax-free dollars compounding in your HSA.

8. Lower monthly health insurance premiums — Since you’re taking on more of the financial risk in a given year with a HDHP, your monthly premiums will almost always be lower. And the HSA (and other emergency funds you’ve set aside), should be there to cover the added financial risk if statistically you happen to draw a short straw… In the meantime, those lower premiums (and possibly the employer’s help in funding your HSA contributions) is helping to come up with the money.

9. And a BONUS reason related to Long Term Care (LTC) — If you start early with an HSA and do a good job growing that money over time, it can help you better prepare for end-of-life care needs. Assistance with activities of daily living (ADLs) such as bathing, dressing, eating, transferring (getting in and out of bed, walking, getting in and out of a wheelchair…), toileting and continence… that can be very expensive so a large pool of tax-free money becomes a valuable asset.
   
   That said, since pulling funds from an HSA to pay for LTC expenses wouldn’t allow you to deduct those medical expenses on your tax return if they exceed the IRS adjusted gross income threshold, next level planning might be to use your HSA for LTC expenses in years below the threshold, while keeping some traditional IRA (or similar tax-deferred) money available so that you can potentially deduct high healthcare expenses in years when you exceed the threshold. Be sure to check with your CPA on the best approach given your unique situation.

Disclaimer: Clients should note that The Wealth Collective will not provide accounting or legal advice, nor prepare any accounting or legal documents. Clients are urged to work closely with their attorney and/or accountant in implementing our recommendations. However, at the client’s request we may recommend the services of a third-party attorney, accountant, tax professional or other specialist. The Wealth Collective is not compensated for these referrals.