While 2020 brought new and unforeseen perspectives to health care, health expenses can arise unexpectedly at any time. While the IRS provides several tax-advantaged tools to help with saving for planned and unplanned medical costs, the most powerful is the Health Savings Account (HSA).
Similar to an IRA or 401(k), an HSA enables the account holder to save and invest for future health care expenses and can even invest in alternative investment options like real estate, private loans, and precious metals.
Ready to invest in alternative assets with a self-directed HSA? Click here to get started and be on your way in a matter of minutes!
Let us look at an example case study to highlight the savings power of an HSA. Mary, a 35-year-old self-directed investor, is married with two kids when she opens an HSA with New Direction Trust Company. She is enrolled in an HSA-qualified high-deductible health plan (HDHP) through her employer, which is a requirement to make HSA contributions. Mary has family insurance coverage allowing her to contribute $7,100 in 2020. (Note: HSA holders age 55 and older can contribute an additional $1,000 per year, while the 2021 family limit is $7,200).
Mary can deduct her $7,100 in contributions from her annual income for tax purposes. Therefore, if Mary earns $50,000 in 2020, she’ll only have to pay income taxes on $42,900. She saves 7.65% on employment tax (FICA), lowering her tax bill by $543. By making a full HSA contribution, Mary saved a considerable chunk of money on taxes, even before growing the HSA itself.
Once deposited into a self-directed HSA, Mary can use her HSA contributions to invest in an asset class she is familiar with. She has been issuing private loans to individuals and small businesses in her community, and now she’s ready to do the same with her HSA. A local family-owned bakery has been struggling during the Covid-19 pandemic, so Mary loans the bakery capital at a lower interest rate than banks can offer to help the bakery stay afloat.
The small business needs $25,000. Mary’s HSA doesn’t yet have this amount, but not to worry—she can partner with herself on the investment. Her HSA will lend $7,100 toward the loan, and Mary will supply the remaining $17,900 from her personal money. As long as the returns remain distinct per the separate investments (i.e., earnings attributable to Mary’s HSA stay in her HSA and vice versa), Mary will not violate the IRS rules on prohibited transactions and self-dealing.
As the bakery pays off the loan and the HSA receives the principal plus interest, Mary finds other private lending opportunities and recycles the capital. Based on prior experience, Mary is targeting a 12% return on her investment.
As the years go by, Mary’s original $7,100 contribution has been re-invested so it is now responsible for $30,000 of her account balance. Unfortunately, her appendix unexpectedly bursts, and she needs to take an emergency trip to the hospital. Mary recovers but incurs a medical bill she had not planned for.
Luckily for Mary, HSA withdrawals for qualified medical expenses are 100% tax free, and the list of such expenses is longer and more inclusive than you may think. This is true regardless of Mary’s age and is also true for her husband and children, as they are dependents on her high-deductible family health plan. Further, Mary did not have to withdraw the money at once. She could simply file the receipt away and withdraw the money tax free at the end of the year, at the end of the decade, or even in retirement. Medical expenses never expire.
Through her HSA, Mary avoids taxes on a significant invested balance. Her original contribution was tax deductible and grew tax deferred to a five-figure balance, while her distribution was tax free because it was used to cover her appendix procedure.
This brief case study does not account for any additional contributions Mary could have made over the years, boosting her balance and investment opportunities. Studies indicate retirees need more than $250,000 for out-of-pocket health care expenses, and Mary is well on her way to planning for this as tax efficiently as the law allows. To kickstart her HSA, Mary could also transfer money from an IRA into her HSA, but she can only do so once in her lifetime, and the transferred balance would count toward her annual HSA contribution limit.
HSAs are a flexible investment that can supplement your retirement portfolio by offering additional tax benefits and helping you save for medical costs, now and into the future. Click here to download our Health Savings Account Investing Guide to learn more or give us a call at 877-742-1270 if you have any specific questions.