Health Savings Accounts Are an Underappreciated Retirement Vehicle

By Jim Krapfel, CFA, CFP
July 2, 2020

Health Savings Accounts (HSAs) were introduced in 2003, but only in recent years have people come around to the idea that they could be an effective means to save for retirement. With ever-increasing healthcare insurance premiums, a growing share of companies are offering high-deductible healthcare plans that are necessary to establish an HSA. In 2019, 58% of covered employees worked at companies that offered a high-deductible plan with a savings account, and 36% of covered employees were enrolled in a high-deductible plan, up from 18% in 2013. The IRS defines a high deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family in 2020.

Figure 1: Percentage of Covered Employees Enrolled in High-Deductible Account-Based Plans

Source: Marsh & McLennan

It works like this – individuals and families can contribute up to $3,550 and $7,100, respectively, into an HSA (and an additional $1,000 “catch-up” contribution for individuals 55 or older) using pre-tax money. Some companies seed these accounts with $500-$2,000 to encourage their use and complement their benefits package. Like long-used Flexible Savings Plans (FSAs), one can use HSAs to pay for qualified healthcare expenses such as doctor’s visits, drug prescriptions, and prescription eyeglasses. (click here for a full list of qualified expenses) Unlike FSAs, the balance in an HSA fully rolls over form year-to-year, and the funds can be invested in the stock market. Almost all HSA administrators allow for investing in the stock market. Most will require you to keep $1,000-$2,000 in a low interest-bearing cash account.

The most powerful feature of HSAs is its triple-tax-benefits. One can not only contribute to them on a pre-tax basis, but savings also grow tax-free and withdrawals are tax-free if used to cover qualified medical expenses. No other retirement vehicle offers these tax benefits. With traditional IRAs and 401(k)s, contributions are made pre-tax and savings grow tax-free, but withdrawals are taxed. With Roth IRAs and Roth 401(k)s, savings grow tax-free and withdrawals are tax-free, but contributions are made with post-tax money.

Given these advantages, it is advisable to greater prioritize HSA contributions. After building a three- to six-month emergency cash fund to cover basic living expenses (or greater, depending on your unique situation, such as saving for a down payment on a house), one should contribute enough into a 401(k) to receive the full employer match. The employer match is truly “free” money after all, subject to a vesting schedule. Here’s some advice you probably have not heard before -- the next allocable savings should flow to HSAs up to the maximum allowed. Only then should one consider allocating the remainder of his or her available savings to the other typically-used options, such as contributing the full $19,500 limit to one’s 401(k), contributing to a traditional or Roth IRA, or contributing to a child or grandchild’s 529 plan.

When realizing a qualified medical expense, one might consider NOT tapping his or her HSA account. By not seeking reimbursement from an HSA, that money can stay in the investment account and grow tax-free for potentially many years. Suppose a 25-year-old contributes the maximum $3,550 per year at the beginning of each year for the next 40 years and earns 7% per year through investing the full balance in the stock market. At a theoretical retirement at age 65, the HSA balance would have grown to $758,314. Then in one’s later years the money can be used tax-free for qualified medical expenses.

Summing It Up

So next time you are evaluating what to do with your savings, give serious consideration to contributing the maximum to your health savings account if you are enrolled in a high-deductible plan, invest the maximum balance allowed, and let it compound over time.

Disclaimer

Advisory services are offered by Glass Lake Wealth Management LLC, a Registered Investment Advisor in the State of Illinois. Glass Lake is an investments-oriented boutique that offers a full spectrum of wealth management advice.

This article is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory, legal, or accounting services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein is based on or derived from information provided by independent third-party sources. Glass Lake Wealth Management believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions in which such information is based.