A few years ago, I started a new job with a new health plan. I had been spoiled post Obamacare in the sense that my employer tried to keep me in a generous plan where it foot much of the bill even with the rising cost of healthcare plans. I noticed the company had begun offering a high deductible plan, but saw the minimum out of pocket costs and a premium being not that much lower than what I was paying for my traditional plan and decided it wasn’t worth it.

When I joined my new employer however, there was only one option: a high deductible plan. I was forced to suck it up and open a Health Savings Account or HSA. At least they gave me a choice of provider. Since I had been out of work for some time, I needed cash immediately and so contributed only a bit to the HSA. I had noted that the plan brochure mentioned it was triple tax deductible and I could take the money if I leave the firm. That all sounded nice, so I contributed but didn’t take it very serious. Little did I know, an HSA is much more than just a way to pay your healthcare expenses.

How Does it Work and Why is it Valuable?

It wasn’t until I was back on my feet financially that I had the breathing space to start looking at my financial options. When I delved deeper into the HSA and it’s benefits, I kicked myself for not contributing more sooner.

When you have a high deductible plan, defined as a plan with a deductible of at least $1,350 for an individual or $2,700 for a family, you are responsible for all non routine medical costs until you spend that deductible within a one year period. Once a new year starts, the bar resets back to $0 and you have to start again. To compensate for shifting the cost burden on to the patient, the government offered the HSA to give you a bit of a tax break as a consolation prize.

The funds can be deducted right from your paycheck and then they are placed in a savings account. You are issued an HSA card to swipe for medical expenses. You can take these funds if you leave a firm, they are like a 401k, it’s your money no matter what.

Triple Tax Advantaged: So what does this actually mean? It means that funds go into the savings account before income tax is deducted. It also means that as the funds grow, they are free from current interest income and future capital gains. In that sense, the funds are pre-tax like a 401k but then they grow and are never taxed again like a Roth IRA. In essence, the government has said, we know this health plan stinks, so here is some money we will never tax.

The Investment Account: The key to what makes the HSA so valuable is the option to invest the funds. In my account for example, as long as you keep a minimum cash balance of $1,000, you can invest the rest in stocks or bonds. This allows your funds to compound over time and eventually be worth much more than what you put in, assuming you invest wisely and don’t touch it. I have mine in a boring conservative growth index fund offered by Vanguard which is 50% bonds and 50% equity.

The Limit: For 2019, the contribution limit for an individual is $3,500 while for a family it is $7,000.

The Restrictions: You can only use the funds for qualified medical expenses. Your healthcare provider usually gives a list of the services, products and co-payments that the funds can be used for. If you do use the funds for something else, you will pay the income taxes on those funds in addition to a 20% penalty.

You can either use your HSA card to pay for current medical expenses immediately (don’t!) or you can pay out of pocket and save the receipt to reimburse yourself from the account later (do this, I will explain).

Although you cannot use HSA funds to pay your premium or non medical expenses, after you turn 65, you can take out funds for whatever you like. The funds will be just taxed at your regular income rate just like a traditional IRA. In addition, they won’t be taxed if they are being used for premiums involving:

• Medicare Part A (for most people this is free anyway)
• Medicare Part B
• Medicare Part D prescription coverage
• Medicare Part C (Medicare Advantage)
• Long term care insurance

Remember, this money isn’t taxed going in and will never be taxed again if you use it right on the way out.

So What?

At this point you may be saying, big deal it’s not a ton of money and I would rather use that extra money to pay my bills, not pay it with after tax money that I can invest.

Hold on there though, remember I mentioned that you can either pay for your medical expenses immediately by using the HSA card or you could pay after tax cash and then reimburse yourself from the account? In the case of the latter, the government doesn’t provide any timeline as to when you have to reimburse yourself, just that you have proof by way of a receipt in case you are audited.

This essentially turns your current bills into tax free lending to your own HSA account. The longer you don’t touch that loan and let it compound in the market, the lower your initial bill gets. If the funds keep growing, eventually you will have reached a point where all your growth has paid all your after tax medical bills and continues to compound as free money (Tip: I take a pic of my receipts and save them on Apple cloud, this way I don’t have to worry about paper receipts and it is backed up if Iblose my phone).

Let me put it another way, those receipts are like IOU’s for yourself with tax free money. If you ever get in a bind and run out of money down the road, you can take out from your HSA as much as the receipts total you have piled up over time and you will pay no taxes or penalty on it. If you have the money to pay for it out of pocket now, why not at least save the receipt and save the HSA money for a rainy day?

To visualize it, let’s assume you have 1 child and you contribute to an HSA until the child is 21 and get a boring 7% return on your investment. The results are below.

What you will end up with is $314,056 that you can tap into via your old medical bills or let compound even more until you are 65. For those of you that are younger, contributing now and getting the benefit of compounding could be immense and would ramp up even higher after if you choose to have a family. That small $3,500 now could be worth a lot when you are older.

So HSA accounts can be a great tool to make a little bit of money go a long way over time. As long as you are willing to harness the power of compounding through low cost index funds and discipline, you could turn this small account into a valuable piggy bank or retirement vehicle. Due to the tax advantages, it could be just as valuable if not more valuable than some of your more traditional retirement vehicles like a 401k or an IRA.

A Disclaimer

In no way am I saying you should go into debt or not contribute to other retirement accounts to fund an HSA account. I am assuming if you are reading this that you are already fairly financially responsible and are looking for ways to save on taxes, increase your returns and grow your net worth. Although if it’s a choice between your IRA or HSA, you may want to choose the HSA which you can read more about here.

It’s also a luxury for anybody to be able to pay all their medical bills without touching their HSA. If you don’t have the income and you need to use that money for your medical bills and treatment for your family, please do. This is just one tip for those that have the ability to take advantage of it.

For those of you that can though, don’t make the mistake I did of putting it off and waiting until later to investigate. The government doesn’t give us much to be happy about but in the case of the HSA we can’t look a gift horse in the mouth. If your high deductible plan has the option to invest in the market, take advantage of it and watch your savings grow.

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