The HSA Tax Saving Strategy for High Income Earners

By: Scott Sturgeon, JD, MBA, CFP®

Would you like to receive more content just like this directly to your inbox? Click here to subscribe!

The HSA Tax Saving Strategy for High Income Earners

For high income earners, saving and investing in a tax-advantaged way is important. Health Savings Accounts (HSA’s) have become increasingly popular in recent years as a way for high earners to save on taxes today, plan for inevitable healthcare expenses and potentially invest for the future. But what exactly are HSA’s and how can they be used for tax-advantaged investing?

What is an HSA?

First and foremost, it’s important to understand that HSA’s are tax-advantaged accounts that can be used to pay or reimburse yourself for qualified medical expenses. They are only available if you’re enrolled in a high-deductible health plan (HDHP), but in exchange for that higher deductible, they offer a triple tax advantage: contributions are tax-deductible, investment growth is tax-free, and withdrawals for qualified medical expenses are also tax-free.

One of the unique benefits of HSA’s is that the funds in the account roll over year after year, unlike Flexible Spending Accounts (FSA’s) which have a “use it or lose it” feature. This means that HSA funds can accumulate over time and be used to pay for future healthcare expenses or even retirement healthcare costs.

But, what many people may not know is that HSA’s can also be used for investing. Many HSA providers offer investment options, such as mutual funds or exchange-traded funds (ETF’s), which can potentially grow the funds in the account even more.

Why invest the funds in an HSA?

Investing in HSA’s can be a smart move for several reasons. First, the funds in the account can be invested for the long-term, allowing for potential growth over time. This can be especially beneficial for individuals who plan to use the funds for future healthcare expenses or retirement healthcare costs.

For example, a married couple could initially contributing $7,000 to an HSA, then continuing to make $7,000 contributions each year for 20 years. At a relatively modest 5% growth rate, at the end of that 20 year period they’ve accrued a balance of $250,000.

*$7,000 initial investment, $7,000/yr contribution over 20 years with 5% compounded annual return

Additionally, investing in HSA’s can also be a great way to diversify your overall portfolio from a tax perspective. Since the funds in the account are earmarked for healthcare expenses, they can serve as a separate investment vehicle from traditional retirement accounts like 401(k)’s or IRAs.

Another advantage of investing in HSA’s is that they are not subject to required minimum distributions (RMDs) like traditional IRA’s or 401(k)s. This means that the funds in the account can continue to grow tax-free and be used for healthcare expenses at any age, even if the healthcare costs were incurred in prior years. And if you don’t end up needing the funds for healthcare? Once you turn 65, an HSA can be treated just like a Traditional IRA with the funds being withdrawn and considered ordinary income without any penalty.

However, it’s important to note that not all HSA’s offer investment options and the fees associated with investing can vary among providers. It’s also important to understand that investing in HSA’s carries the same risks as any other investment and the value of the account can fluctuate.

Is investing an HSA right for you?

Before deciding to invest in an HSA, it’s important to consider several factors.

First, assess your current and future healthcare needs. If you have a lot of high ongoing medical expenses or anticipate high healthcare costs in the near future, it may make more sense to keep the funds in the account more liquid for immediate use. Conversely, if you have adequate cash on hand each month to cover your deductible and any out-of-pocket expenses, fully funding an HSA & investing it may actually be a better option than using those funds to reimburse yourself.

Additionally, consider your overall investment strategy and risk tolerance. If you have a well-diversified portfolio and are comfortable with risk, investing in HSA’s may be a great option for you. However, if you’re not comfortable with risk or already have a lot of investments, it may be best to keep the funds in the account more liquid.

Another important consideration are the fees associated with investing in HSA’s. Some providers charge high fees for investment options, which can eat into your potential returns. Be sure to compare fees among providers and choose one that offers low-cost investment options.

It’s also important to understand the rules and regulations regarding HSA’s and investing. The IRS has certain guidelines for HSA’s, including limits on contributions that change annually and restrictions on certain types of investments. Consulting with a tax professional or fiduciary, fee-only financial advisor can go a long way before investing in an HSA to ensure you’re in compliance with the rules.

If you’re a high-income earner that’s looking for another place to save and invest, reduce your tax liability, and diversify your investment holdings, consider looking into a Health Savings Account as a long term strategy. If you’re unsure whether the strategy makes sense for your individual situation, consider scheduling a consultation with us to review your current financial situation. Working with a fee-only, fiduciary financial advisor can help in offering advice and guidance that’s in your best interests to align your personal goals and finances.

Still curious to learn about more financial planning topics? Check out the content below!

Roth IRA Conversion: Does it Make Sense for You?

 

The #1 Hidden Retirement Risk You May Not Be Aware Of