By Mallon FitzPatrick and Vicky Jung
June 23, 2023 – High-income earners may not be optimizing their Health Savings Accounts (HSAs), overlooking an easy and effective means to cover future health costs and transfer wealth. HSAs offer tax-advantaged investing that may fund future healthcare expenses and combat increasing medical costs. Like all retirement vehicles, HSAs provide tax-advantaged opportunities to save. However, HSAs are unique because they have triple tax benefits, like 529 college savings plans but for healthcare. Funds contributed to HSAs are tax-deductible, the growth in the account is tax-deferred, and withdrawals used to pay for qualified healthcare expenses are tax-free.
Historically, U.S. healthcare costs have risen on average by more than 5% per year.[1] HSAs can stave off healthcare inflation by using today’s dollars to invest on a tax-free basis and enjoy compounding growth for many years. While a $7,500 procedure today may cost up to $32,000 in 30 years, contributing $7,500 to an HSA today will allow the taxpayer to grow their money tax-free and deduct $7,500 from their taxable income today. At an 8% annual average return, the initial HSA contribution would grow to approximately $75,000 after 30 years. The $75,000 in the HSA would more than cover the cost of the $32,000 procedure.
HSAs are not subject to required minimum distributions and qualified medical expenses may be reimbursed at any time during one’s life. Individuals can pay out-of-pocket for current healthcare costs and reimburse themselves at a future date, effectively using the HSA like a Roth IRA up to the unreimbursed amount. At death, the surviving spouse may inherit an HSA, and the benefits of the account are transferred as if it was their own. Non-spouse beneficiaries are required to include the entire value of the HSA in their gross income and pay taxes. The account is no longer an HSA and may be used for any expense without penalty.
High-income earners who have maxed out contributions to their non-HSA tax-deferred accounts may consider using an HSA as a wealth transfer opportunity if they have non-dependent children under the age of 26. The child meeting these conditions may enroll in their parent’s high deductible plan and open an HSA independently from their parents. The child and the parents may contribute a maximum of $7,750 to each HSA under the family plan. A married couple with a child meeting the criteria could contribute up to $15,500 between the two HSAs. The child may contribute their own money, or the parents can gift funds to the child’s HSA using their annual gift exclusion. The benefit of this strategy is that additional deductions are available for the household since the child may take a deduction for the HSA contribution on their own tax return.
A well-invested HSA has multiple benefits. It provides tax savings today and a hedge against healthcare inflation tomorrow. When properly utilized, an HSA may act as a tax-free savings account in retirement years. Tax-free withdrawals are permitted for future qualified medical costs and reimbursement of past post-tax medical expenses. Make sure to keep the receipts! Lastly, tax deductions for contributions today make HSAs a powerful savings tool. Families with non-dependent adult children have the added advantage of saving more by opening an HSA account for the child under the family plan. HSAs offer an easy and effective way to supercharge one’s nest egg and transfer wealth by means of a tax advantaged account.
Disclosures
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[1] Source: https://ycharts.com/indicators/us_health_care_inflation_rate#:~:text=US%20Health%20Care%20Inflation%20Rate%20is%20at%200.72%25%2C%20compared%20to,long%20term%20average%20of%205.18%25.