Do you really know how to use your Health Savings Account? Most people don’t. A large number of people who have HSAs use them as “health spending accounts,” and “spending” is the opposite of “saving.” HSA owners aren’t at fault for not maximizing their HSAs’ potential, though. There simply isn’t a great deal of information available on what they can really.
On the one hand, more of you are probably familiar with Health Reimbursement Accounts (HRAs) or Flexible Spending Accounts (FSAs). The drawback to having access to HRA or FSA funds is that they work on a “use-it-or-lose-it” basis. Whatever you don’t spend, you lose. People who transition from HRAs or FSAs to HSAs are conditioned to spend.
If you’ve done some basic reading on them you probably know that HSAs don’t work the same way. These articles will tell you that whatever money is left over at the end of the year “rolls over” to the next. That sounds great if you’re accustomed to forfeit anything you don’t spend.
There are two problems with how those sources discuss HSAs. First, they present them in the same light as HRAs or FSAs, except, they state, unused funds “roll over”. Let’s be clear: an HSA is not like an HRA or FSA. The funds in a Health Savings Account are yours, not part of a company’s health benefits. Unused dollars don’t “roll over” from one year to the next like unused vacation. In fact, an HSA is more like an IRA, but for medical expenses. That is, the money is yours, and it can go where you tell it.
The second problem with most information circulating about HSAs is the notion of “left-over funds”. These sources take spending the money in your HSA as a given. Any little bit left over can go in the bank. This is certainly an option, but it doesn’t exactly maximize the HSA’s potential.
Before discussing how you might maximize your HSA, let’s take a quick look at what an HSA actually is and how it works. First, you do have to be covered by a High Deductible Health Plan (HDHP) to make contributions to your HSA, but the money continues to be yours even after you’re no longer covered by the HDHP. Then, you establish a Health Savings Account, which is an IRS-designated custodial account that offers tax-deductible contributions and tax-free distributions for qualified medical expenses. That is, money goes in tax-free and money comes out tax-free out money. Money you don’t have to pay taxes on, ever.
CAVEAT LECTOR: if you take money out of your HSA for anything other than a qualified medical expense before you’re 65 years old, Uncle Sam imposes taxes and a 20% penalty. After you’re 65, the HSA can act like a Traditional IRA. That means that distributions for qualified medical expenses are still tax-free, but distributions for other things – dream vacation to the Cayman Islands, perhaps – work just like distributions from a Traditional IRA. You pay income tax on the amount distributed, but no penalty.
Importantly, you don’t have to spend the funds in your HSA according to someone else’s schedule; you can save them. If you have low medical costs, and you’re able to cover them out-of-pocket, you can leave the funds in the HSA, to grow tax-free. You can even reimburse yourself later as long as the expense was incurred after you established the HSA.
Not spending the money in your HSA is a sound saving strategy, but with current interest rates hovering around “abysmally low” for savings accounts, it’s not likely to put your hard-earned money to work. However, while the ability to contribute to an HSA ceases when HDHP coverage stops, the ability to invest doesn’t. As mentioned above, HSAs work much like IRAs – the money is yours, and you can invest in alternative assets if you so choose. Of course, stocks, bonds, and mutual funds can make up part of your HSA portfolio, but they don’t have to make up all of it.
Your HSA can invest in all the things the IRS allows for IRAs, and a Self-Directed IRA custodian like New Direction Trust Company can help you establish an HSA investing in real estate, precious metals, private equity, private lending…the list goes on. In fact, except for life insurance, collectibles, and any prohibited transaction involving self-dealing, your only real limit is your creativity. You can use your personal expertise with your HSA. The returns on these investments certainly have the potential to be much higher than a savings account’s annual yield.
Given that the projected costs of post-retirement health care for someone retiring now exceed $250,000, an investment vehicle with the potential for high returns coupled with tax-free distributions for qualified medical expenses is a valuable tool.
What if you’re currently covered by an HDHP and want to make sure you can pay the amount of your annual deductible, but you want the rest of the money to work for your future? You can have more than one HSA, and you can transfer funds between them, much like an IRA. That means you could have one “cash” HSA where you keep the amount of your yearly deductible in the event of an emergency, and a long-term investment HSA that you use to build wealth for your future medical expenses, long-term care needs, and as a supplemental source of retirement income if needed.