The Under-the-Radar Retirement Account

“We interrupt this article posting for a brief comment on the recent stock market decline…..”

I wasn’t going to write about the recent decline in the stock market but given the volatility of the moves over the last several days, it probably bears some mentioning.   For those who don’t know, the S&P 500 index (broad measure of stocks) has declined about 5.4% since October 8th.  So what’s going on? From my own research it appears the sell-off is being driven by new fears that the global economy (mostly outside the US) is weakening combined with the fact that we will no longer have the benefit of the Federal Reserve’s “backstop” of their various interest rate-suppression tactics. Adding to these issues, is a general accumulation of negative sentiment building up with geopolitical concerns (ISIS advancements, Russia-Ukraine conflict) and the uncertainty around the ebola virus.

However, my take is this is probably more of move in step with a “normal” market rather than the exception.  By that I mean we have been through a multi-year period of low volatility and amazingly consistent gains.   So most recently, we’ve been conditioned to believe sharp moves down are not common.

As individual investors, we must keep in mind a few things. First, we must have our portfolios aligned with the time-frame for which we will need the money.  If you need money next week for a down-payment on a home, you probably shouldn’t be fully invested in the stock market.  Conversely, if you have 40 years until you retire you can probably afford to take more risk by investing in stocks, no matter what they’re doing this week.  Second, what’s often overlooked is that many “safe” bond prices have actually increased in value (as noted by the drop in yields), which speaks to the value of a diversified portfolio.

In a nutshell, I don’t know what the stock or bond market will do tomorrow, next week, or next month. But over the next 20+ years, I believe it is worth the risk to invest in a diversified, low-cost portfolio of assets that have a solid track record of growth in our country.  So we should all focus on controlling what we can control:  spending less than we earn, diversify, keep investment costs low and minimize our tax liability (legally).

Now onto my “regularly scheduled” article……

The Under-the-Radar Retirement Savings Account

I know it’s hard to believe but the Halloween decorations adorning our neighborhoods are a friendly harbinger of the close of the calendar year, which will be upon us in a couple months.  Of course the inevitable rush of the holidays will also be upon us (as indicated by the Christmas trees already on sale at Lowe’s), which can certainly shift financial planning topics to the back burner.

However, it’s important to use this time before the end of the year to optimize our income tax liability by taking advantage of any & all deductions for which we are legally eligible, which includes contributions to IRAs and/or 401(k)s.  But the merits of maximizing contributions to the retirement accounts are generally well known.  This is why today I am detailing what I believe is an under-the-radar but very effective income tax saving strategy for high-income earners that is easy overlooked.  What is it?  Your HSA (Healthcare Savings Account).

Why?  Because it’s one of the few income tax advantaged accounts NOT phased out by earning high income.   So let’s start with what HSAs are, the restrictions and why I think they could be considered another de-facto retirement savings account.

HSAs Defined: HSAs are personally owned “bank accounts” (for lack of a better term) which hold funds used to pay qualified medical expenses for the account owner.  Contributions to these accounts are tax-deferred, which means you get to deduct it from your income.  If you withdraw funds for anything other than medical expenses, the funds are taxed as ordinary income and may be subject to an additional penalty.  If / when you leave your employer or retire, you keep your account and all the funds in it.

HSA Eligibility:  To be eligible to use one of these accounts, you must participate in a “high deductible” health care plan with your employer.  If you’re self-employed, or self-insured you are subject to the same stipulation.  According to the IRS, this means your plan must have an annual deductible of $1,250 for self-only coverage or an annual deductible of $2,500 for family coverage. There are also maximum out-of-pocket limits with the plans, which are $6,350 for self-only coverage or $12,700 for family coverage.

HSA Contributions & Usage Restrictions: Account holders for self-only coverage can contribute and deduct $3,300 per year while family-coverage account holders can contribute $6,550 per year.  If you’re 55 or older, you can add $1,000 to those amounts (totals $4,300 and $7,550 respectively).  Big Caveat:  Any contributions by you to another medical account (Medical Savings Account) or contributions from the employer, reduce these contributions dollar-for-dollar. So if you are 50 years old and your employer kicks in $2,000 to your HSA, you can only contribute and deduct $4,550 ($6,550 – $2,000).

  • Qualified Expenses: Basically, you can withdraw and use the funds any time for qualified medical expenses. Qualified expenses are un-reimbursed medical or dental expenses for the taxpayer, spouse and dependents including prescriptions.  Health insurance premiums are not qualified unless for COBRA, Long Term Care or if you’re unemployed.

The Math Behind the Advantages of HSAs:  The way I see it, there are two big advantages to HSAs- one before retirement and one during retirement.

  • Before Retirement: Before you retire, you can contribute funds to the accounts and save on your income taxes.  For example, if you contribute $5,000 per year and you are married with over $200,000 of adjusted gross income, you would save about $1,400 in taxes every year.  But here’s the rub:  If you make this much money, you have VERY FEW deductions available to you but, the deductions for HSAs are NOT limited by income!  If you think you’ll ever need to spend money on medical expenses (which we all usually do), this is a GREAT thing to employ in my opinion.
  • During Retirement: One of the little-known provisions of the HSA is that when the account holder is eligible for Medicare (usually age 65), they can withdraw the money and use it for ANY reason without the penalty. It is still taxable as ordinary income (like an IRA distribution) but what this means is that you effectively have a tax-deductible IRA-like account with funds that can be used for any reason when you’re eligible for Medicare!  In my view, it’s a great deal.

Bottom Line:  People who earn upwards of $200,000 and more annually have very few available tax deductions that aren’t “phased out” and therefore out of reach.  If you’ve worked hard enough to earn that kind of income, you have access to an HSA and you think you will someday need to spend money on medical expenses (won’t we all?) you should consider maxing out your contribution to an HSA.  Not only will you save on income taxes while working, you’ll also have another pool of money from which to draw in your “golden years”.

One Comment

  1. Good article. It seems like our HSA is great for all our medical needs, and if we are healthy, it becomes retirement money.

    Reply

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