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Lane Keeter, CPA

Partner: Tax Consulting, Estate Planning, and Heber Springs Managing Partner

A Viable Investment Vehicle – the Health Savings Account

The IRS recently announced the 2023 annual cost of living adjustment of the maximum contribution that can be made to health savings accounts, or HSAs, for eligible persons covered by qualifying high deductible health insurance. The 2023 limits were raised to $3,850 for self-only coverage and $7,750 for family coverage. 

These adjustments are roughly four times what they were from 2021 to 2022, and with inflation currently soaring, future adjustments are poised to be even greater. Also, for those who are age 55 or older, and extra $1,000 can be contributed.

For years, in my experience as a tax practitioner, most of my clients who had an HSA used them mostly as a funnel to simply pay current medical expenses with pre-tax money. In other words, they would make current contributions to the account in an amount roughly equal to their medical expenses for the year, take the related tax deduction and then withdraw the funds back out of the account to reimbursement themselves for the medical expenses incurred, leaving little behind in the account. 

Nothing necessarily wrong with this approach, as it does at least save some on the income tax bill. But consider this - according to one source, the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2021 may need about $300,000 in after-tax funds to cover their health care expenses in retirement (2022's estimate has not yet been released but no doubt it will be greater). 

Given the above estimate, and the longer-term tax benefits of an HSA as compared to other investment and retirement savings vehicles, the "funnel" approach referred to above may be short-sighted, leaving valuable financial benefits on the table that could go a long way in meeting medical expenses during retirement. 

Many people have the misconception that HSA funds must simply be held in a low interest-bearing bank account, but this isn't the case. Rather, an HSA can be invested for the longer term in stocks, bonds, mutual funds, etc., just like other investment and retirement accounts.

Granted, like any investment vehicle, there is investment risk involved, as the assets are subject to the market's volatility. They can go up in value (as historically over time they tend to do), but they can also lose value, as we are seeing with recent market sell offs (which some view as an opportunity to buy stocks, as they say, "on sale").

But if the long-term goal is financial security in retirement, and a subset of that goal is to have enough to pay your medical expenses, fully investing to the maximum extent possible using an HSA makes a lot of sense given its inherent advantages.

First, as already mentioned earlier, contributions to an HSA are tax deductible, unlike funds put into a typical savings or investment account. So right off the bat, you have more money left in your pocket to save in other ways or use for current expenses. 

Once in the account, any income earned on or growth in value of the investments is not subject to income tax, and never will be assuming they are subsequently used to pay or reimburse you for qualified medical expenses incurred. 

Also, HSA's have an advantage, at least in my mind, that tops all types of IRA's in that an HSA in a sense combines the best of both a traditional IRA and a Roth IRA. What do I mean by that?

With a traditional IRA, when you make contribution, you get a tax deduction like you do an HSA, that is assuming the deduction isn't limited due to your income. However, when funds are withdrawn, the distribution is taxable income to you, and if withdrawn prior to age 59½, subject to early withdrawal penalty. A Roth IRA, on the other hand, doesn't provide a deduction when funded, but in most cases, withdrawals are tax-free, including earnings.

The HSA, being the best of both worlds, gives you the upfront deduction of a traditional IRA (without the income limits), the tax-free growth while in the account the same as both types of IRAs, and the tax-free withdrawal character of a Roth IRA when used for medical expenses, making it an excellent and viable investment vehicle to prepare for retirement.

Flexibility, tax benefits, and a long-term financial planning focus on retirement age medical expenses make Health Savings Accounts, if you qualify to have one, a potentially potent weapon in your retirement planning arsenal.

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