Your HSA is Even Better Than a Roth IRA: Triple Tax Benefit Explained

Often referred to as “the triple tax benefit,” the HSA or “Health Savings Account” warrants a closer look. In this post I’ll explain how, given the tax benefit, it is one of your best investments. I’ll also explain a little-known hack to get your account to six figures in as little as 9 years.

The first tax benefit from the HSA is the contribution benefit. All the money that you put into the account goes in before tax and in that way, it operates just like your 401(k) or your traditional IRA.

Whatever you put in is money that you do not pay taxes on that year.

Now, because all good things have a limit, the government does limit your contributions. For the 2021 tax year, individuals can contribute $3,600 and families can contribute up to $7,200. Some employers will help contribute to an HSA and while that amount does count toward your yearly limit, it, again, goes in before tax. So, in short, money put into your HSA (up to your limit) is a direct tax savings.

This brings us to the second tax benefit from the HSA –the distribution benefit. As long as you are using the funds to pay for “qualified medical expenses,” the money you take out is not taxed.  

Let me repeat that—the money taken out is not taxed.

Here is where the HSA differs from and ultimately beats out both the traditional IRA or 401(k) and the ROTH IRA—with the traditional IRA, the money goes in without being taxed, but you are taxed when you withdraw it. With the ROTH IRA, the money goes in having paid tax, and you are NOT taxed when you withdraw. With the HSA, it goes in UNTAXED and comes out UNTAXED—again, as long as you are using it for qualified medical expenses.

You can refer to a lengthy IRS publication to see what qualifies as medical expenses to get more specifics, but suffice to say, the HSA wins when it comes to tax benefits. And that’s just with the first two benefits—which brings us to the third.

The third tax benefit from the HSA is that the money, when invested, grows tax free. Effectively, your HSA is just like your ROTH IRA in this respect—going back to the second benefit, if you use the money for qualified medical expenses, then not only are your contributions withdrawn tax free, but all the interest and compound interest you accumulate grows tax free as well.

The average American will spend around $400,000 in health-related expenses over the course of a lifetime, and many of these expenses pick up after age 45. If you think of the HSA as a retirement account for health expenses, it makes sense to work to max out your contribution limit each year.

This brings us to the little-known hack—as of now there is no rule dictating WHEN you withdraw your medical expenses from your HSA –in other words, as long as you keep meticulous records and track your receipts, you can wait 5, 10, 15, or even 20 years before pulling that money out of your HSA. If you make the decision to pay for your medical expenses out of your monthly budget instead of your HSA, you are keeping that money in an account to grow tax free, interest included, until you withdraw it.

Let me break that down a bit more clearly—let’s say you have $3,000 in medical expenses this year. If you pay for that out of your regular monthly budget, that $3,000 stays in play in your HSA earning, if you’re using an investment strategy like The 12% Solution, 12 percent a year. After six years, that $3,000 is now worth $6,000, and all of it comes out tax free if used on medical expenses.

Contrast that with the scenario of withdrawing the $3,000 from your HSA to pay for your medical expenses and then investing that money in a traditional brokerage account. You’ll still get to $6,000 after six years, but $3,000 of that will come back to bite you at tax time.

This is the hack that will help get your HSA to over 6 figures in just 9 years, on average. If you are contributing the full family amount of $7,200 and keeping that money in the account, while paying your medical bills as they come in, then that money will grow and, assuming you are earning around 12% annually on average, then in just 9 years, you’ll see over $100,000 in that account, all tax free. Keep it going 15 years, and you’ll be looking at close to $270,000.

All in all, the HSA is a great tax savings tool to use in conjunction with your 401 (K) and ROTH IRA for retirement planning.

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