Tax Angle #9. Magnify Your HSA By Letting It Sit For 30 Years

A series of strategies for tax-wise investors. Table of Contents.

Probably the only triple play in personal income taxes is a Health Savings Account. It delivers a deduction, tax-free growth and a tax-free withdrawal.

If you have a high-deductible health insurance plan, you (or your employer) can put money into an HSA, getting a deduction on the way in. This is a superdeduction, one that reduces adjusted gross income (and thus is more valuable than most itemized deductions). The money compounds tax-free, just as it would in an IRA. Years later, you can take it out tax-free if you use it to cover out-of-pocket medical costs incurred after you joined the high-deductible plan.

This look-back feature of the account is powerful. If you play your cards right, the HSA beats a plain old IRA, which is going to be taxed on exit if it’s deductible on the way in. Like IRAs, HSAs can be invested in stock index funds and other things with handsome long-term rewards.

How to play this game? Veer off the usual pattern of using HSA balances to immediately cover your co-pays and deductibles. Instead, pay those things out of your checking account. But keep the medical receipts.

Now let the HSA compound, tax-free, preferably for a long, long time. At some point well into retirement, fish the receipts out of a drawer and use them against a tax-free withdrawal from the HSA. What you will have, in effect, is a super-IRA to pay for retirement living. If the HSA balance exceeds cumulative medical expenses (unlikely), the excess becomes a standard IRA, taxable on exit.

For more detail, see Turn Doctor Bills Into Retirement Income.

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