The Health Savings Account Strategy That Not Enough People Are Talking About

October 17, 2017

I was talking to a colleague of mine earlier this year about how awesome Health Savings Accounts are, and he threw out a little-known use of these delightful accounts that made the bogus alarm go off in my head. Even though he is a well-respected and tenured CERTIFIED FINANCIAL PLANNER^TM practitioner who is on the CFP® Board, I didn’t actually believe him. I had to see if for myself, but it’s true. Maybe you’ve heard about it, but it doesn’t get much press (yet).

Qualified HSA withdrawals do not have to be taken in the year in which the expense was incurred.

That’s right — there is no statute of limitations as to when you can reimburse yourself for a qualified medical expense as long as you incurred the expense after your HSA was open and funded (provided you hang on to your receipts through the years). There are some pretty cool implications to this fact.

Qualified HSA withdrawals do not have to be taken in the year in which the expense was incurred.

If you max out your HSA over a period of many years, you can build up quite a nice balance of tax free money. For example, let’s say you start maxing out at age 30 and continue to do so for the next 35 years. At today’s contribution rate, a single person could sock away $119,000, including catch-up contributions assuming the money is not invested, and therefore doesn’t grow at all. If the money were invested in mutual funds and grew at even a conservative rate of 4%, you would have an account worth over $250,000.
Furthermore, let’s say that over those 35 years, you were able to pay your medical expenses from non-HSA accounts, and you kept track of all of those expenses. This part would vary greatly according to how healthy you are, but let’s just say you end up with an average of $1500/year (growing at a rate of 4%/year) in medical expenses on your list. This would mean that you would have about $110,000 eligible for reimbursement — money that you could withdraw from your HSA tax-free.
Then, when you decide to retire, you have this nice sum of money that can be used strategically in different ways.

Consider a few scenarios:

Maybe the market tanks one year and you don’t want to take too much out of your retirement accounts to avoid having to sell into a down market. Assuming it was invested more conservatively, you could tap into your HSA to cover some expenses without taking as much of a hit to your retirement accounts and incur no tax or penalty.
Perhaps you are on the verge of tipping over into a tax bracket that would require you to pay higher capital gains tax. You could tap into the HSA to prevent that from happening as well.
If you qualify for a subsidy for your health insurance through the Affordable Care Act, you should be aware that your subsidy is only good up to certain income limits. In order to keep the subsidy, you must not cross the limit. So let’s say you have retired a little early and are funding your early retirement with IRA withdrawals while getting healthcare through the exchange and you qualify for a subsidy based on your income. If you are in danger of taking out even $100 over your earnings limit from your IRA to cover expenses, this would be a great time to be able to tap into an HSA account and keep your ACA subsidy.
If you are collecting social security, your adjusted gross income, or AGI, is part of the calculation for determining how much of your social security income is taxable. If you can fund part of your lifestyle with HSA money (which won’t increase your AGI), you may be able to pay less tax on your social security income.
Even after you use up your tax-free withdrawals based on medical expenses from prior years, your account will still provide you major benefits. Maybe you choose not to buy a long-term care policy. You can hold onto the HSA to give you some peace of mind that you have something to fall back on if you need special care or incur a lot of medical expenses. If you have Long Term Care, you can use your HSA balance to cover the premiums (although some limitations apply).

In all of these scenarios, you have the ability to use money that was never taxed, either on the front end when invested or on the back end when withdrawn. Think about that. If you are in the 25% tax bracket, it’s like getting a 25% discount on all your medical expenses or whatever you end up spending the money on. You can also take the money out for non-medical expenses after you turn age 65 and pay income tax on the withdrawal but incur no penalty.

Assuming you can afford to pay your medical expenses out of pocket before you retire, accumulating funds in an HSA account can be a great option to consider!

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