How to Turn Your HSA into a Tax-Free Retirement Account

11/26/2018

If your company’s healthcare plan is HSA-eligible, drop everything you’re doing and start contributing to it. Yesterday. Do not sleep on the Health Savings Account!

Let’s back up, shall we? If you’re like, WTF is an HSA and WHY should I care, allow me to cover the basics.

If you have a high-deductible health insurance plan, you’re eligible for a Health Savings Account. The HSA is a tax-free vehicle intended to be used for medical costs. Let’s say you hit up the dermatologist and your health insurance is all, “Deal with your acne yourself!” You can use funds in your HSA to pay for your zit cream.

There are some obvious tax benefits to utilizing your HSA, and I've found myself grilling both friends and coworkers about whether or not they're maximizing this hidden gem.

For one thing, the money you contribute reduces your taxable income. The maximum annual contribution for an individual is $3,600, so if you put $3,600 in your HSA, it reduces your salary (in the eyes of the IRS) by that much. If you’re someone who’s right on the cusp of a higher tax bracket, this might be a good way to skirt the higher tax dig.

For example, if you make $40,000, your tax bracket is 22%. If you contribute $3,600 annually to your HSA, the IRS thinks, “Okay, this person makes $36,400,” thereby lowering you to the 12% tax bracket.*

*Note that the progressive tax system means your income is divided into brackets and taxed appropriately; being in the 22% bracket doesn’t mean your entire income is taxed at that rate—just the amount that exceeds the previous bracket’s upper limit.

Here’s a great graph from NerdWallet that illustrates this principle more clearly:

Moreover, the money you put in goes IN tax-free and comes OUT tax-free (so if you’re like, Hey, I’m going to pay for this zit cream with my money either way, this is a way for you to avoid paying ANY TAXES on that money). The HSA can be used as an investment vehicle—something I’m still digging into and figuring out within my own Optum Bank portal and will follow up on in a future post.

But let’s say you’re someone who literally never has health issues. UTIs? Never heard of them. Glasses? 20/20 vision. You’re the walking picture of health.

Two things:

ONE.
You probably won’t ALWAYS be, so any money you save in this account can be used for medical expenses 30 years down the road because you tweak your back playing with your pet robot (not to be confused with the FSA, which resets every year and is a raw deal, in this expert’s opinion).

TWO.
If you retain your invincible status to old age, once you’re 65, the HSA functions as a regular IRA (Individual Retirement Account) and will be taxed in your tax bracket when you take it out (but it went in tax-free and GREW tax-free, which is #YUGE).

It’s kind of a win/win.

You don’t have to contribute anything crazy—definitely take care of your 401(k) and contribute up to your company match first (and if you’re not doing that, start doing it—last week).

But if you’ve got a few extra hundred bucks hanging around each month in your checking account, direct them to your HSA instead so they can grow and help you avoid taxes. Woohoo! #FederalGovernmentWho?

Main Takeaway

The HSA functions as a regular IRA (Individual Retirement Account) post-age 65, so even if you don't use the un-taxed money for medical expenses, it can be withdrawn at your regular tax rate as retirement income.

11 Comments

Anon

11/28/2018 09:11:49 am

“the HSA functions as a regular IRA (Individual Retirement Account) and will be taxed in your tax bracket when you take it out (but it went in tax-free and GREW tax-free, which is #YUGE).”

The money does not grow tax free. It grows tax deferred. You are correct when you say they don’t pay taxes until they take the money out.

In your previous article you also recommend using Robin Hood to start trading. You failed to mention they are in the middle of a class action lawsuit. They also get paid for order flow. So as a client you may have little to no cost for trading but they are making A LOT of money off of you trading with them and you aren’t necessarily getting the best price for your trades and are potentially paying more.

You also recommended index funds which are not a bad investment vehicle if you are properly diversified and it applies to your investment strategy and goals. When looking at index funds they typically do a little worse than the index they are tracking. Also wig mutual funds (or any investment for that matter) you cannot guarantee returns, because no one knows what is going to happen in the market. Guaranteeing returns is ILLEGAL.
You can try to base your investments off of previous returns but that doesn’t really mean anything.
Almost anything trading in the market has gone up since 2008 so basically you could be blindfolded and throw a dart at a dartboard and the investment you picked probably went up.
Now that we are experiencing market volatility it is crucial to make sure your accounts are properly diversified and that you are continually monitoring the account to know when to make the proper adjustments.

When talking about low cost investing make sure you are doing all of your research. Fidelity Investments now has 4 index funds with a 0.0% expense ration and no minimum purchase for their mutual funds. Now if you only have $10 you can invest that $10.

Please do thorough research before your post.

All the best,
Someone that works in the financial industry.

Katie

11/28/2018 09:44:17 am

Thanks for your comment! I'll try to address all your points in order for clarity and I'll do my best at brevity.

1. "The money does not grow tax free. It grows tax deferred. You are correct when you say they don’t pay taxes until they take the money out."

KG: My research and source (https://www.choosefi.com/102r-the-triple-tax-savings-of-health-savings-account/) stated the money in an HSA grows tax-free, confirmed here by Investopedia (https://www.investopedia.com/articles/personal-finance/091615/how-use-your-hsa-retirement.asp). It's possible I'm misusing terms or fiduciary jargon; however, I believe the meat of the statement holds true.

2. "In your previous article you also recommend using Robin Hood to start trading. You failed to mention they are in the middle of a class action lawsuit. They also get paid for order flow. So as a client you may have little to no cost for trading but they are making A LOT of money off of you trading with them and you aren’t necessarily getting the best price for your trades and are potentially paying more."

KG: Yes, I make my recommendations based on my own positive or negative experiences. I was unaware of the class action lawsuit but would've noted that if I were aware of it. Upon further research into your comment, I couldn't find anything about a Robinhood class action lawsuit, just one against T.D. Ameritrade (Source: Bloomberg, https://www.bloomberg.com/news/articles/2018-10-15/robinhood-gets-almost-half-its-revenue-in-controversial-bargain-with-high-speed-traders). Would you mind sharing your source?

3. "You also recommended index funds which are not a bad investment vehicle if you are properly diversified and it applies to your investment strategy and goals. When looking at index funds they typically do a little worse than the index they are tracking. Also wig mutual funds (or any investment for that matter) you cannot guarantee returns, because no one knows what is going to happen in the market. Guaranteeing returns is ILLEGAL."

KG: I have never on my site guaranteed anyone an ROI beyond colloquialisms and humor—however, investing over the long-term when properly diversified is, in my opinion, a good decision that will offer SOME sort of return. Any time I've noted a percentage return, I use the standard 8% average.

I choose index funds over mutual funds for several reasons, all of which I learned from books like A Random Walk Down Wall Street and other sources like the ChooseFI podcast and general investment knowledge—as Warren Buffet himself, perhaps the greatest investor of all time says, the market will outperform managed money in the long-term. Again, a personal decision that I frame appropriately in my posts alongside my recommendations.

4. "You can try to base your investments off of previous returns but that doesn’t really mean anything.
Almost anything trading in the market has gone up since 2008 so basically you could be blindfolded and throw a dart at a dartboard and the investment you picked probably went up. Now that we are experiencing market volatility it is crucial to make sure your accounts are properly diversified and that you are continually monitoring the account to know when to make the proper adjustments."

KG: Yes, I absolutely agree! Proper diversification is key.

5. "When talking about low cost investing make sure you are doing all of your research. Fidelity Investments now has 4 index funds with a 0.0% expense ration and no minimum purchase for their mutual funds. Now if you only have $10 you can invest that $10."

KG: That's great to know, thank you! I was aware Fidelity and Vanguard were in a little bit of a fee war racing to the bottom. That's a great option. I opted for Vanguard originally for their low fees, but I'll explore Fidelity too and follow up if I find anything notable.

6. "Please do thorough research before your post."

KG: I do my best to thoroughly research these topics through reading, listening to podcasts, poking around online, and talking to friends who work in finance. I rarely post based on one source.

However, ultimately, I am not an expert—I didn't go to school for this. I'm merely someone who really loves personal finance and wants to make it as accessible and understandable (and cheap) to the masses as possible.

At the end of the day, I'm always happy to own up to my mistakes or miscommunications. I post based on my own experiences and learnings, and try to share the best habits and hacks I find with my audience of other beginners and young people.

Thanks for your comments and feel free to email me anytime at kmgatti@crimson.ua.edu.

David

12/29/2018 05:48:21 pm

In terms of the zero fund fees that fidelity offers it is worth looking into the tax efficiency of those funds. Even with higher fees the Vanguard funds could have better returns unless its in some sort of tax-deferred account.

Rachel

11/28/2018 09:54:30 am

I find it funny this was anonymous...

12/30/2018 07:54:09 am

@David, that's a great point. That's a little beyond my scope of knowledge too, so I'm glad you can speak to it, but I know Vanguard has always been very highly recommended from a lot of investors I trust so I'm comfortable keeping my money in their funds. Thanks for your comment!

11/28/2018 10:14:43 am

“I choose index funds over mutual funds for several reasons”

AN INDEX FUND IS A MUTUAL FUND.

I understand you are trying to respond professionally and help people, but maybe you should do the research and keep it to yourself.

Telling people to invest and save for retirement isn’t bad, but I would leave any further discussion to some one who has the appropriate licenses.

Reading and getting the education for yourself is good...for yourself.

Going back to where you said “I choose index funds over mutual funds for several reasons” among MANY other statements is reason enough people shouldn’t take this advice.

It was nice of you to site your sources in your response, but why didn’t you do that in your original post?
Also you responded in 30 minutes? How much time did you really have to research what I said compared to what you believe. A quick Google search will not give you the answers you need.
You question my sources? I am an investment advisor for a large brokerage firm. I get these emails daily about what is going on in the industry (class action against Robin Hood) but they are internal. I’m sure you can find something on the Internet.

Education lesson for you first though:
There are two types of mutual funds a) index b) active.
Index funds track an index (typically doing a little worse than the index they are tracking.
Actively managed funds try to out perform the benchmark they are tracking, to do so they use their core and extended asset classes to reduce the risk the fund is taking on to try and improve their returns.

11/28/2018 10:25:51 am

Frankly, I think your response perfectly illustrates why people choose not to involve themselves with the financial industry in the first place: an attitude of self-importance and condescension.

Quibbling over the jargon is unhelpful for laypeople who don’t understand—colloquially referring to an unmanaged fund as an index fund is normal and commonplace in both investment texts and otherwise.

I understand your entire industry is predicated on people paying you to tell them what to do with their money which is why I presume you have a problem with my posts and want to attack semantic discrepancies.

Lastly, I asked you to share a source because I couldn’t find anything pertaining to the claim you made. If it’s proprietary information you learned in your workplace as an investment advisor at a large brokerage firm, you probably shouldn’t post it publicly on my site—especially since you questioned why I didn’t share it in MY post.

Thanks again for your time. I'm sure the clients you're billing for it right now would appreciate it more, though.

11/28/2018 10:38:01 am

Excerpt from 2013 letter to Berkshire Hathaway shareholders from Warren Buffett:

"My money... is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers."

Source: http://www.berkshirehathaway.com/letters/2013ltr.pdf

Does it matter

11/28/2018 11:01:24 am

“Quibbling over the jargon is unhelpful for laypeople who don’t understand—colloquially referring to an unmanaged fund as an index fund is normal and commonplace in both investment texts and otherwise.”

You are wrong again.
“Referring to an unmanaged fund as an index fund is normal”
WRONG!!
ALL MUTUAL FUNDS ARE MANAGED. This does not matter if it is active or index all funds have a fund manager.

And the jargon over active or index I explained to you! We have this conversation with clients day in and day out to help them have a better understanding of their accounts and their investments.

Being in the industry there’s nothing I love more than assisting clients with making sure they have the appropriate strategy in place, doesn’t matter if they are managing the account themselves or if we are doing it for them.
The important thing is know that EVERY client is different. No one is in the same situation and no one’s plan will be the same.

https://www.bloomberg.com/news/articles/2018-10-15/robinhood-gets-almost-half-its-revenue-in-controversial-bargain-with-high-speed-traders

Here’s the link that took all of one google search and it was the first result.

Maybe you should hold off on any further investment articles until you have your Series 7, 63, 66, and CFP.

But hopefully you have a good day and I just want to point out that I am not the only one who feels this way about your posts.

Name

11/28/2018 11:15:00 am

“I understand your entire industry is predicated on people paying you to tell them what to do with their money which is why I presume you have a problem with my posts and want to attack semantic discrepancies“

The firm I work for does not charge anything for advice. You pay a trading fee for trading and IF you have a managed account you pay an annual fee for that (no additional fees outside of the annual management fee). Those are the only fees a customer would pay.
Again you should probably get more familiar with the industry before you assume everyone is charging fees for everything.

11/28/2018 11:18:00 am

I'm not going to continue to address the same points with you over and over again, however—did you even read that article?

Because (A) it's the one I sent in my original comment to you as the only source I could find regarding the practice you mentioned, so yes, I know it came from a quick Google search and (B) nowhere in the article does it say Robinhood is facing a class action lawsuit—just that T.D. Ameritrade is, as I mentioned in my original comment.

I cordially invite you and the rest of your anonymous friends to no longer visit my site if you have take issue with my posts.

Your comment will be posted after it is approved.

How to Turn Your HSA into a Tax-Free Retirement Account

Main Takeaway

Leave a Reply.

What's this?

Who's KG?

Categories

Download my free budget tool

Rent or buy calculator

Invest with Robinhood. Get free stock.