Health Savings Account - The Only Triple Tax -Free Retirement Account

While listening to podcasts I came across a couple that mentioned the Health Savings Account (HSA) as the best retirement plan out there because of it's ability to be tax free when you contribute, while you let it grow, and when you withdrawal.

I found myself thinking that can't be true, these people are lying! Retirement accounts are supposed to be taxed at some point. Believe me, the government wants their cut, so how is this possible?!

Surprise! It's not actually a retirement account.

An HSA is a tax-advantaged savings account for people enrolled in a high-deductible health insurance plan. Since you could have more out-of-pocket expenses, because of the higher deductibles, the government allows for tax incentives to help people save for those costs. 

The way it is suppose to work is people with an HSA contribute pre-tax dollars to the account and withdraw the money tax free when paying for qualified medical expenses. ​​

Normal Retirement Accounts
Typically there are two types of retirement accounts, your tax-free contribution accounts or tax-free withdrawal accounts.

Tax-Free Contribution Accounts
These are things like your 401k, Traditional IRA, etc. Your contributions to these accounts are made pre-tax, meaning they don't count against your income now. Let's say you make $50,000 and contribute $10,000, you'll only pay income taxes on $40,000 for that year. 

The government is saying, we are okay with you not paying taxes on it now because we'll let you grow it tax-free and we'll collect taxes when you withdrawal later on. 

These accounts are great to reduce your overall income now.

After-Tax Accounts
These are things like your Roth 401k, Roth IRA. Your contributions to these accounts are made after tax, meaning they count against your income now. Using the example from before, if you made $50,000 and contribute $5,000 you'll pay income taxes on $50,000.

The government is thinking, okay we took our taxes now so you can grow your money tax-free and not pay anything when you withdraw.

These accounts are great because you'll hopefully allow them to grow significantly and not have to pay any taxes on them later.

Health Savings Account
The HSA is designed to be a savings account for medical expenses that can provide some tax benefits. 

But, if done right, it can provide the best parts of both accounts described above, tax-free contributions and tax-free withdrawals.  Or in other words, completely tax-free money!

The magic of it is that you can make those tax-free withdrawals on a qualifying medical expense at any time you want!

As of now there is no rule stating you must withdraw money to directly pay for medical expenses or that you must withdraw in a certain time frame after a medical expense. You just take out the money whenever you want after you've had a qualifying medical expense. Assuming it was after you've opened your HSA of course.

See It In Action
We have gone over all of this and now you want to see how it would actually work. Let's assume I spend $300 a year on medical services and figure I can get away with having a high-deductible health plan (HDHP).  

With my brand new HDHP I decide to open up an HSA and max it out, and in 2019 the max is $3,500. Because this contribution is put in pre-tax I am able to reduce my taxable income by $3,500, meaning less taxes for me! Always a crowd pleaser!

​So when the time comes to go to the doctor and spend my $300 I have two real options. I can choose to use my tax-free dollars to pay for it now, or I can pay for it in cash now and reimburse myself later. 

That whole choosing when I pay myself back part is what makes it so great. If I'm able to pay the out of pocket expenses now, and keep the receipts (keep the physical copies but also make a digital one incase it fades) I can let my tax-free dollars continue to grow tax-free to withdrawal whenever I need. 

The Health Savings Account allows you to save money by not paying taxes on my $3,500 contribution, I also have $3200 that is growing tax-free, and $300 that will continue to grow tax free and I can withdraw whenever I want! 

Where The Magic Really is!
You may be thinking what happens if I save all this money and don't have any expenses or enough to pull out all my money? Well, that'd be awesome but what is magical about the HSA is when you turn 65 you can treat it like a traditional IRA and withdraw whatever you want. This will be treated as taxable income though. ​​

Things To Keep In Mind

• Maxing out your contribution will lower your taxable income.
• If you contribute via automatic deduction you avoid FICA taxes.
• You can invest your HSA into low cost index funds (mine has a minimum of $2100 before I can start)
• If you pay medical costs out of pocket you can withdraw that money whenever you want tax free if you keep your receipt (keep a digital copy!)
• If you haven't had enough expenses it turns into a traditional IRA at 65.
• Check to see if your employer will make contributions (mine does $700 a year- more free money).
• If you wait to pull out the money later it will naturally be less because of inflation. $100 now will not be the same as $100 in 20 years. 

​After finding out all of this was true I switched at the first chance I could when my job had its open enrollment and will be using an HSA starting the fall of 2019!