The Best Retirement Account Series #1
Ranking the best retirement accounts ending with a waterfall strategy
Starting a series on ranking the best retirement accounts. One to come each week and build on each other.
Coming in at #1…
The underappreciated Health Savings Account.
Triple-tax advantaged
Carry medical costs
Medical Equity
No income required
Change at 65
TL;DR— Assuming you’re in a High Deductible Healthcare Plan (HDHP), an HSA1 is arguably the best retirement account you can contribute to; paying the least in taxes and building towards future medical equity effectively turns into an IRA when you hit 65.
Phew, I’m all hot and bothered after writing those out. I hope you are, too.
Triple-tax advantaged
It’s the only “tax-perfect” account. Every contribution for qualified medical expenses escapes payroll, capital gain, and income tax. AKA triple-tax advantaged!
Payroll taxes are officially known as FICA (Federal Insurance Contributions Act), which funds Social Security programs. Since contributions by employers to an HSA are not income, you don’t pay the 7.65% tax! (6.2% for Social Security and 1.45% for Medicare)
A quick example shows the power of this tax-saving strategy.
Let’s say you’re married, make $100k, and live in Indy. Your marginal federal tax rate is 12%, plus FICA at 7.65%, plus State at 3.23%, and local tax at 1.62%, meaning your effective tax rate is 20%, phew!
But if you contribute the family max of $7,300 ($3,650 if you’re single) to an HSA, then you’re saving:
Federal: $876
FICA: $558
State/local: $354
Total: $1,788
Put another way, you’re giving the government $1,788 more a year than you have if you’re not using this account. Or if you’re trying to sell it you’d say that’s a 25% return on maxing out your HSA contributions.
You’re not paying income tax on HSA contributions because they’re not considered income. Your employer’s contributions into the HSA are not income much like a 401(k) employer addition is not income.2
Riveting, I know.
Carry medical costs
When a provider says, “we are HSA eligible, " please don’t use your HSA!
There is no reimbursement deadline for qualified medical expenses. Meaning any medical bill you pay out-of-pocket while you have an HSA can be reimbursed later in the future at any time.
Using HSA funds today when you’re young is slightly mental accounting. If you’re putting money into your HSA and then spending it, you can probably pull from an after-tax account and use that money. Let the qualified medical expenses accumulate over time.3
Suppose you rack up $20k in qualified expenses bills from now until retirement. In that case, you can then take reimbursement from your HSA without any tax ramifications — distributions from your HSA are a REIMBURSEMENT and NOT income!
Controlling your income is extremely important when enrolled in Medicare.4 Your Medicare5 monthly costs are determined by your income and increase ~40% each income bracket you go into (Check for yourself). It makes sense to try and control your income as much as possible and save yourself any added costs.
Build Medical Equity
A Fidelity6 study estimates that couples at age 65 retiring this year will need to cover $315,000 for medical costs (or think out-of-pocket). This number doesn’t include nursing-home or long-term care costs, which can quickly increase the number by $100k or more annually in those facilities.” Wonder what those costs are going to be when YOU retire. Probably not lower.7
With that much expected medical care cost in the future, we need to build medical equity — meaning assets specifically for future medical expenses.8
No Income Required
You need earned income to contribute to retirement accounts (IRA and Roth IRA). Can you guess what will be number two in our retirement account rankings?
You can fund an HSA with “investment income, rental income, gifts, savings, liquidated investments,” and other proceeds.
HSA contributions are not limited like the maximums for other accounts. For example, you can only put $20,500 in your 401(k) or $6k in your Roth IRA, but those don’t affect your HSA contributions. Also, they don’t have Required Minimum Distributions and are not included in provisional income in retirement. That’s important for Social Security.
Change at 65
Once you turn 65 and enroll in Medicare, you can no longer contribute to an HSA.
Sad.
However, you can still take out proceeds for qualified medical costs (such as Medicare A, B, and D9) and take proceeds out for non-qualified expenses. You have to pay income taxes, so effectively, your HSA becomes an IRA, but a better one, because you never paid FICA taxes on it! Boom.
Yes, I know…it’s weird thinking about your 60’s and 70’s. But with a few automated tweaks, you can start making sure you’re taking advantage of one of the best retirement accounts out there!
Have thoughts or questions that can be answered in a post? Feel free to reach out, and I will do my best to craft a witty post in your honor.
Main Source: Quoted sections are from HSAs The Tax-Perfect Retirement Account by William G. Stuart
What’s fun about HSA is having autocorrect always change it to HAS.
Really bored and want to know everything? Here you go: https://www.irs.gov/publications/p969
You need to be tracking these expenses over time.
Isn’t it kind of weird that retirees have a quasi-one-payer system for their healthcare?
Isn’t it fun to think about things that will impact you like Medicare when you’re 65?! We have so much to look forward to such as death and higher medical bills.
https://www.fidelity.com/viewpoints/personal-finance/plan-for-rising-health-care-costs#:~:text=According%20to%20the%20Fidelity%20Retiree,and%20how%20long%20you%20live.
Because let’s be honest; the chances the American healthcare system gets better, more affordable, and easier to navigate is probably near zero percent.
Only reason not to be doing this is if we have a future one-payer healthcare system, and, welp, we clearly don’t like changing anything in this country
C had some comments and got kicked out. Kidding. C is considered Medicare HMO or PPO, and you can use your HSA funds for that, too)