How The Power Of Tax-Deferred Growth Makes Your HSA Your Best Long-Term Investment Vehicle
September 4, 2008
Vol. 4, Issue 8
People carry HSA plans because they’re less expensive than copay plans, the deposit to your HSA is tax deductible, and you can use money from your account tax-free to pay for virtually any medical expense. But sometimes people forget one of the most powerful benefits of all: the special way that an HSA is treated by the tax code enables you to build wealth faster than through any other type of investment.
Planning For The Future
My son Wiley IV just started kindergarten this year. Having put off parenthood for as long as we thought was prudent, I now find myself as one of the older fathers among Wiley’s friends. When I’m 65, he’ll be just 25, and by the time he’s my age I’ll be 85 years old. The last thing a parent wants is to be a financial burden to their children, so putting money aside for the future is high on my mind. If I end up in a nursing home or with high medical expenses, I don’t want him to have to pay for it. Because of the special tax advantages that an HSA offers, funding my Health Savings Account is one of my main strategies.
Wiley IV in Orange Beach, Alabama
Tax Advantage #1: Immediate Tax Write-off
There are three important tax advantages you receive when you open and fund your Health Savings Account. The first and most immediate benefit is an immediate tax reduction. Any money you deposit into your HSA is 100% tax deductible on line 25 of your 1040. This is considered an “above the line” deduction, meaning it is taken directly off your income in order to calculate your adjusted gross income.
The contribution limits in 2008 are $2900 for individuals, and $5800 for families. Individuals who turn 55 or older in 2008 can also deposit (and deduct from the income upon which they pay taxes) an additional $900.
So a 55 year old couple who maximizes their HSA contribution can deduct up to $7600 from the income they report to the IRS. If they are in a 28% tax bracket in a state with a 5% income tax rate, they will reduce their income taxes by a whopping $2508.
Tax Advantage #2: Tax-Deferred Growth
If you have any interest bearing investments that are not in tax-deferred accounts like Health Savings Accounts or IRAs, you know that you pay taxes on your earnings every year. For similar investments in stocks or mutual funds, you pay capital gains taxes in the year that you sell those investments.
The long-term effect of paying taxes on your earnings has a tremendous impact on how fast your investment can grow. For instance, if you deposited $100 per month into an investment that was growing at 8%, you would accumulate $18,417.
But if you were subject to a 25% tax rate, then the pre-tax $100 would be an investment of only $75/month after taxes. And the 8% return would be reduced to 6% after a 25% tax. So your end result after ten years would be only $12,352 - a full 33% less!
Tax Advantage #3: Tax-Free Withdrawals
The average couple will need over $200,000 to cover medical expenses during retirement (that are not paid by Medicare!). But if you will need to be cashing in taxable investments in order to free up that money, you'll need even more. Even money from your IRA or 401k is taxed when you start making withdrawals.
Only an HSA will enable you to sell your stocks or other investments in order to get cash to cover medical expenses - without having to pay a penny in income taxes on that money. Virtually everyone will experience higher medical expenses during retirement than in their younger years, so it is important to have as much money in your HSA as possible for when you'll really need it.
In fact, funding your HSA should have priority over funding your SEP, your IRA, your Roth, or your 401k. Though it is certainly good to fund your retirement account, none of these other investment options offers the triple tax advantage of Health Savings Accounts.
Fund Your Account!
If you currently have an HSA-qualified health insurance plan, you have until April 15th to make your 2008 contribution. If you do not currently have an HSA-qualified health insurance plan, you must get one in place no later than December 1st.
The earliest you can fund your account for 2009 is January 1st. For 2009, contribution limits increase to $3000 for individuals and $5950 for families. Individuals over age 55 in 2009 can contribute an additional $1000.
While putting money aside for the future can often be a challenge, funding your HSA can be one of the smartest financial moves you can make.
P.S. - Next month will discuss some of the options you have with HSA-qualified health insurance plans, and how to get the coverage you need at the lowest available cost.