Health savings accounts (HSAs) can serve as an essential part of individuals’ financial strategies, particularly for those who have the capability to cover healthcare expenses out-of-pocket while letting their HSA funds accumulate over time.
By covering medical costs independently and providing room for HSAs to appreciate, account holders can effectively benefit from compound growth and maximize tax advantages, which become increasingly important over an extended period.
Before committing to using an HSA primarily as a long-term investment, however, individuals should conduct thorough research.
Allowing HSA funds to expand
The initial consideration for investing in an HSA is determining when the funds will be used.
As previously highlighted, HSAs benefit from triple tax advantages. The value of tax-free compounding grows significantly with prolonged investment. For example, an investor contributing $6,000 into an HSA and achieving an annual return rate of 5% over ten years would see their total climb to almost $10,000 tax-free.
On the other hand, someone contributing post-tax income into a taxable brokerage account would invest $4,500 (assuming a 25% tax bracket). With a similar 5% return rate annually, she’d end up with $7,412 after a decade and face further taxation during withdrawal, leaving her with less than $7,000.
Strategizing your HSA asset allocation
HSA assets can align with other retirement assets, where longer timeframes justify more aggressive investment approaches. However, nearing retirement, a strategic plan for liquidating these assets becomes crucial, factoring in probable healthcare costs. Identifying which costs are eligible for tax-free HSA withdrawals is beneficial.
For example, Medicare supplemental policies don’t qualify for tax-free abstractions, but premiums for Medicare insurance (Parts B, C, and D), long-term care insurance within IRS limitations, and some out-of-pocket medication costs do.
Based on estimated annual healthcare expenditures, retirees can adjust their account holdings accordingly.
HSAs in the retirement withdrawal order
Moreover, retirees must assess the role of HSAs in their distribution lineup compared to other assets. Typically, HSAs should follow behind taxable accounts and traditional IRAs and 401(k)s. The rationale is that HSAs’ tax-free growth and withdrawals for qualifying healthcare expenses are advantageous benefits worth preserving.
Yet when it comes to HSAs vs. Roth IRAs, both offer tax-free withdrawals and don’t require minimum distributions. However, unlike Roth IRAs, inherited HSAs lack specific tax benefits.
Consider the beneficiaries of your HSA
It’s also crucial for HSA investors to contemplate their accounts’ designated recipients. Naming a spouse typically makes sense, but the surviving spouse might opt to spend the HSA funds sooner or designate a charity as the beneficiary. Unlike a non-spousal human heir who inherits an HSA, a charitable organization isn’t liable for taxes on the received amount.
