Rethinking Retirement Accounts: Beyond the 401k and IRA
What if I told you …that the 401k wasn’t the greatest pound-for-pound retirement account? ...that your IRA contributions would fail to protect you from FICA taxes? ...that sometimes you shouldn’t use life (or death) insurance? …that there is one account that can outrun the tax man?
Navigating the Tax Terrain: A Look at Financial Vehicles
The iconic, award-winning ESPN 30 for 30 documentary series is arguably the best show the storied network has ever produced. Each episode tells a story of conflict and perseverance through lives spent off-camera much more than they were on TV entertaining us. They add color and context to performances that were already great stories in their own right.
Finances and taxes, on the other hand, are not exactly Emmy-winning material. There is a reason ESPN never made a documentary about financial planning and investment vehicles. If they did, though, I’m convinced they would have made it about the Health Savings Account (HSA). Here’s what it would look like.
The Health Savings Account (HSA) Revealed
Setting: Large corporations, small mom-and-pops, home offices, workshops, highways, diners, golf courses, and everywhere that business is conducted in the United States.
Characters: You, the American worker, Uncle Sam, and his army of IRS agents.
Plot: The story begins with you getting your first job with the goal of saving up for that shiny new thing you’ve always wanted. After one week, you finally get that first paycheck, the dollars and cents promised to you in exchange for your time and labor by your enterprising employer.
Conflict: You excitedly open the envelope to see the payoff from all your hard work and …“Who the heck is FICA?!” Every week, the muscles in black leather jackets come by to collect the boss’s cut.
Resolution: Utilizing devices of Uncle Sam’s own making, you pull a financial “miracle on ice” move on the IRS and slip money right through their fingers, legally, of course.
The Triple Tax Advantage: Unlocking the Power of the HSA
As you well know, the IRS takes a cut of your income when you earn it. They also like to take a cut if you take those earnings, invest them, and have the audacity to earn more money on your investment. Now, there are well-known tools used in this battle to keep as much of your earnings as you can – the 401k, the IRA, the Roth IRA, the tax-sheltered annuity, and life insurance, to name a few – and they’re all powerful vehicles to help you tactically pay taxes as efficiently as you can. However, they all have this in common: you’re either going to pay taxes on the money before you put it in or when you take it out.
Maximizing Your HSA: Strategies for Long-Term Financial Health
Here’s why the HSA gets to be Samwise Gamgee in this story – the real hero. If you are eligible to contribute to an HSA, the money, up to the annual limit, is contributed pre-tax. While it’s in the account, it can be invested in stocks, bonds, mutual funds, and ETFs on a tax-deferred basis, meaning there are no taxes on interest, dividends, or capital gains. AND, if you use the funds to pay for qualified medical expenses, they come out tax-free. This is known as a triple tax advantage (3 for 3 instead of 30 for 30 - get it?). Bonus: Unlike your retirement account contributions, like a 401k, Health Savings Account contributions also avoid FICA taxes.
Let me say that again. The money you earn, contribute to an HSA, invest, and withdraw for qualified medical expenses is completely tax-free. Good luck matching that anywhere else.
A strategy we often recommend to clients is to max out your HSA contribution each year ($3,850 for individuals and $7,750 for families in 2023), continue to pay for medical expenses through normal operating accounts, and let that baby grow. Take complete advantage of the tax-deferred earnings. We have seen HSAs with hundreds of thousands of dollars in them, and with the rising costs of medical care, especially in retirement, that’s a good resource to have in your back pocket.
HSA Considerations: Factors to Evaluate Before Opting In
So the natural question we often hear is, “How big should I let it get?” Although everyone’s situation is different, the answer for many is “as big as you can.” See, there are a couple of other great HSA features I haven’t mentioned yet. First, HSA dollars aren’t limited to current-year expenses. As long as you incur qualified medical expenses after you open the HSA, you can use HSA funds to cover that expense or reimburse yourself at any time. Secondly, once you turn 65, there is no longer a 20% tax penalty for using HSA dollars for non-medical expenses. In this case, you’ve mimicked a traditional IRA, but without RMD requirements, that you can use for any retirement expenses. Additionally, an HSA with a remaining balance upon the owner’s death could become your spouse’s HSA or also pass tax-free to a qualified charity if you so desired. However, if the account is left to a non-spouse beneficiary who is not a qualified charity, like a son or daughter, the entire account becomes taxable – not what you would prefer if there is a sizeable balance. As always, prudent planning is key here.
Now, let me be clear (Obama impression voice). I am not saying that everyone should have an HSA. First off, Health Savings Accounts are only able to be used in conjunction with a qualified High Deductible Health Plans (HDHP). Secondly, there are reasons, possibly medical or financial or both, why a different insurance setup would be better for you. However, if it is an option available to you, definitely consider it and consult with your financial advisor.
Provista Wealth Advisors in Greenville, SC, provides peace of mind through personalized asset management, expert estate planning, and retirement planning. Navigate your financial journey with confidence. Rest Assured, We Have A Plan. Give us a call at (864) 696-2410 or send us a message to schedule your free introduction meeting.