EP 103: HSAs – Supercharge Your Retirement Savings With This Powerful Account

by Peter Lazaroff | Jun 7, 2023 | Podcast

There isn’t a better retirement savings account than a Health Savings Account (HSA).

Listen now and learn:

How HSAs actually work
Ways to HSAs to supercharge your retirement savings
Advanced planning strategies that leverage an HSA’s flexibility

Listen Now

Show Notes

I don’t think there is a better retirement savings account than a Health Savings Account (HSA).

For many people, HSAs offer a compelling mix of tax breaks and other savings that can keep their health insurance costs down. But under the right circumstances, these accounts offer an even more powerful—and largely underappreciated—chance to boost your long-term savings and provide a nest egg to offset the rising cost of health care later in life.

When it comes to picking a health insurance plan, the options can seem confusing. For years, I avoided my company’s high-deductible health insurance plan with a health savings account (HSA) because it felt scarier than simply paying the monthly premiums and predictable co-pays of a PPO plan.

I have a hunch that many people are in the same boat—they don’t bother with an HSA because of the extra legwork required and it’s easier to stick with what is familiar. But after taking a closer look, I realized how much an HSA had to offer and ditched the PPO for an HSA-eligible high-deductible plan.

How an HSA Actually Works

HSAs are special accounts used to pay for medical expenses and other qualifying health-related costs.

In 2023, contribution limits for individuals are $3,850 and $7,750 for families. Those 55 and older can contribute an additional $1,000 as a catch-up contribution.

Your HSA contributions are tax-deductible, and they grow tax-free when you invest them, just like the money in your 401(k) and IRA.

As long as you use the funds for qualifying medical and health-related costs, you won’t pay taxes on the HSA money you use.

You get a tax break on the front end, a tax break on your money’s growth and income, and a tax break on the backend at withdrawal when used for qualifying expenses…That’s a triple tax break that literally no other retirement savings account can match!

Now before you get too excited, you must be enrolled in a qualified high-deductible health plan (HDHP), which may not be a good fit for you.

The way to determine if an HDHP is a good fit is to compare your expected medical costs against the plan’s details. You can get a decent estimate of your expected medical expenses using one of the calculators on your insurer’s website.

Choose HDHP if:
[Expected Medical Expenses] < [Savings in Premiums + Employer Contributions + PPO Deductible]

(If you wouldn’t get a tax break via a Flexible Spending Account under a PPO, then you could also include the tax break for HSA contributions to the right side of the equation.)

Start by adding up the potential savings in premiums over a PPO plan, the value of the employer match, and your total PPO deductible. Now compare that amount to your expected medical expenses.

If your expenses look to be higher than the value of all those benefits, you’re probably better off sticking to a PPO plan and not worrying about the HSA strategy. This may be the case if you have a chronic condition or anticipate a major medical expense like having a baby or major surgery.

But if your medical costs are likely to be lower, then an HDHP with an HSA is usually the better choice…and now we can start talking about supercharging your retirement savings with an HSA.

Using Your HSA to Its Greatest Potential

When I talk about using an HSA as a retirement savings vehicle, this is really a strategy for high-income earners who can afford to leave their HSA contributions invested while paying for medical expenses entirely out of pocket.

Here’s why: If you can contribute the maximum allowable amount each year to your HSA (currently $3,850 for an individual and $7,750 for a family), and then can manage to pay your medical expenses out of regular cash flow, you can leave those HSA contributions invested for years to enjoy compound growth.

Of course, paying for your medical expenses without tapping your HSA savings requires you to have a healthy emergency fund or sufficient cash flow to cover any large, unexpected medical expenses.

You also might want to pay closer attention to the treatment you receive and what you’re billed for.

Many people prefer the convenience of saying yes to whatever tests the doctor wants to run and letting insurance handle the bills. But when you’re paying out of pocket, you have to take ownership of your care and make cost-effective decisions.

In return for that extra effort, though, you’re getting a powerful tool for retirement.

By investing your HSA savings as you would your retirement savings—typically in a diversified mix of mutual funds and ETFs that offer the opportunity for long-term growth—you’ll build a tax-free fund dedicated to health costs in retirement, which are likely to represent a significant portion of your future budget.

This approach to managing your health insurance won’t work for everyone, but it’s worth considering for those in the right financial circumstances.

And even if you end up dipping into your HSA savings to cover some medical bills, you’ll still receive tax breaks on your contributions and the benefit of lower monthly premiums.

HSA Advanced Planning Strategies

There’s one more wrinkle to the HSA rules that you need to understand to fully leverage these accounts.

If you keep the receipts for qualifying medical and healthcare expenses you incur while paying out of pocket, you can reimburse yourself later with tax-free withdrawals associated with those past expenses.

Let me give you an example.

Suppose in 2023, my family contributes $7,750 to an HSA. Throughout the year, we incur a variety of medical expenses including doctor visits, prescriptions, and over-the-counter medications. Maybe we even have an unexpected medical procedure along the way. Since we are investing the $7,750 we contributed to our HSA, we pay for all of these expenses out of pocket, BUT WE KEEP THE RECEIPTS.

Fast forward 30-ish years to when we’re retired. Because we diligently invested our annual HSA contributions, we now have more funds available than what’s needed to cover the cost of healthcare in retirement. And because we’ve digitally stored our receipts, we can make tax-free withdrawals associated with our past healthcare expenses and then use those funds for expenses of any kind (not just qualified healthcare costs).

This strategy is a pretty nifty opportunity. I personally use an app called Lively to snap photos and easily categorize my healthcare receipts to use for future withdrawals.

There’s another way to use this rule to your advantage during your working years.

Assuming that you’re saving receipts from medical expenses that you pay out of pocket, the HSA becomes another source of emergency liquidity should you need it for any number of reasons.

Lastly, there is always the ability in retirement to treat your HSA much like you would a traditional 401(k) or IRA. Even if a withdrawal isn’t health-related, you would only owe income tax on those funds and no additional penalties – so in this case you would have still enjoyed the tax-break up front and the tax-deferred growth.

Next Steps

There are lots of reasons to love a Health Savings Account (HSA).

If you’ve never used a high-deductible health plan, accessing an HSA probably requires you to step out of your comfort zone and take more ownership over your healthcare expenditures. But the opportunity to add a triple-tax-advantaged retirement savings account is well worth it.

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Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.

Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.

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