Many people (from Millennials to Baby Boomers) have a general understanding of the importance of an IRA, 401(K) and even a solid savings account to amplify their personal “financial arsenal” on their quest to achieving their “good life” goals. But have you considered how you might leverage a Health Savings Account (or HSA) to benefit your overall financial situation?
What is an HSA?
Health Savings Accounts (HSAs) were signed into law by President George W. Bush in 2003 as part of the Medicare Prescription Drug, Improvement, and Modernization Act. The account is funded with pre-tax dollars, grows tax-free and allows tax-free withdrawals if used for qualified expenses – a triple win! Even better, most states (except for California, Alabama and New Jersey) allow state tax deductions on contributions. However, payroll taxes may apply.
To be eligible for an HSA, you must have a high deductible health plan — this is generally any plan (including Marketplace plans) with a deductible of at least $1350 for an individual or $2700 for a family. For 2019, an individual can contribute $3500 to his HSA and a family can contribute $7000. Further, if you reach the age of 55 or older in 2019, you can add an additional $1000 to your account. Some employers make contributions on your behalf, which is an added bonus, but those contributions do count toward your annual total. Keep in mind that if you are enrolled in Medicare, you cannot contribute to an HSA because Medicare is not a high deductible health plan.
Qualified HSA Expenses
What constitutes a qualified expense under an HSA? The easiest answer is any expense for which you must pay out of pocket – deductibles, copayments, and chiropractor services, to name a few. You may also use the HSA to pay for dental and vision expenses as long as you have a dental or vision policy. You may not use your HSA to pay for over-the-counter drugs that are not prescribed by a doctor and you may not use your HSA to pay for insurance premiums; however, once enrolled in Medicare, you can use the HSA for Medicare premiums.
Sounds great so far, right? Well, it gets even better. After attaining age 65, the HSA acts somewhat like a Traditional IRA (individual retirement account). While you can still use your HSA to pay for medical expenses and make those withdrawals tax-free, you are now allowed to make non-medical expense withdrawals without incurring a penalty, such as paying for your child’s education. You would, however, need to pay income tax on the withdrawal amount, just as you would with a Traditional IRA. In contrast, if you make a withdrawal pre-65 and the withdrawal is not used for a qualified expense, you will incur a harsh 20% penalty.
Why should Millennials, in particular, pay attention to HSAs?
For starters, there is no “use it or lose it” rule with HSAs as there is with Flexible Spending Accounts (FSAs), so you don’t need to be mindful about contributing more than you anticipate incurring in expenses. In addition, this account can be invested like you would with a 401(k) or IRA. This really allows you to take advantage of compounding growth, which is particularly valuable considering the increasing cost of healthcare. Of course, if you do expect to use a portion of the account for qualified expenses, that portion should be kept in a stable investment such as a money market fund.
As someone who is part of the Millennial generation and has studied the effects of small changes over time when it comes to investing, I can honestly say time is our biggest asset —the sooner we begin saving for the next chapter of our lives, the easier that next chapter will be.
For example, if you review the chart at right, constructed by NerdWallet, it shows an approximate annual savings needed by a 30-year-old to reach $1 million dollars by age 67. If your portfolio earned an average 8% return, you would need to save approximately $4500/year from Age 30 to Age 67 to reach $1 million by Age 67. While $4500 seems like a lot (trust me, it is) and can be an intimidating number to save, the best way to achieve this goal is to pay yourself first — meaning have the funds directly debited from your paycheck so you never even see them.
Soon enough you’ll get used to this amount being debited and you won’t even realize it’s not showing in your checking account. But jump ahead 37 years and your account is estimated to be valued at $1 million! That’s what I call building your arsenal.
To learn more about HSAs or constructing a savings plan that is right for you and your financial situation, contact any member of your McKinley Carter Wealth Services team.