HSAs offer unique tax advantages that may be more beneficial than 401(k)s and IRAs. Financial professionals advise that people get their full 401(k) match from their employer and then fully fund their HSA. Additionally, HSAs are advantageous because they can be used to reimburse oneself for future out-of-pocket cost at any time.
Choosing from the array of accounts available to savers can seem like an impossible endeavor. 401(k) plans, individual retirement accounts, 529 plans, high-yield savings accounts, taxable brokerage accounts, flexible spending accounts, and health savings accounts may be hard to keep track of. As each saver has different needs, the most suitable financial strategy may vary. However, one clear direction appears: After saving enough money to get the full company 401(k) match, putting the next dollars in a health savings account (if one is available) is a good idea. According to financial advisors, this option is "like a Roth IRA, but extra strength," according to Sabino Vargas, a certified financial planner and senior financial advisor at Vanguard Group.
Carolyn McClanahan, a CFP based in Jacksonville, Florida, and a member of CNBC's Advisor Council, stated that HSAs often go unnoticed in regards to their beauty, but they truly are beautiful due to the incredibly high tax benefits they provide. These tax benefits are three-fold: contributions are not taxed, investment growth is deferred, and withdrawals are exempt from taxation if used for qualified healthcare costs. The majority of taxpayers will never be charged taxes on their HSA money, unlike other retirement accounts such as a pre-tax or Roth IRA.
Analysis from a Vanguard report indicates that $1 invested in a pre-tax or Roth IRA would be worth $2.98 after 25 years, while $1 into an HSA would be worth $4.29. Various assumptions were made about investment returns and tax rates. Carlos Vargas of Vanguard states that HSAs are essentially "an off-label account for retirement preparation" since health-care costs are unavoidable in old age. Additionally, HSAs have the advantage of being portable, allowing savers to take the money with them if they switch employers. It is suggested that people save enough cash in their HSA to cover their insurance deductible and invest the remainder as they would with retirement funds; one should try to pay for current health costs out of pocket so that investments can grow, with receipts for such payments kept for future use.
The IRS considers qualified medical expenses to adhere to the rules of the tax deduction for medical and dental expenses, laid out in Publication 502. This comprehensive list covers a broad spectrum of healthcare costs. If funds from a Health Savings Account (HSA) are used for non-qualifying medical expenses, they will not benefit from one of the three tax advantages connected to the account. This will result in HSA users having to pay income taxes when withdrawing funds, just like an IRA or 401(k). Participants younger than 65 have to pay an extra 20% penalty in addition to the income tax.
Now, not everyone has the option of opening an HSA. Only people enrolled in a high-deductible health plan are eligible, which is becoming more common but many employers may not provide it. In certain cases, people may opt out of this plan and instead go with a traditional co-pay health plan.
Most people are usually limited in their budgeting, so there isn't much (if any) spare money available after necessities to put in savings or pay down debt.Experts suggest to never miss out on the full employer match of 401(k) savings plan. As advised by Vargas, "We never want to leave free money on the table."401(k) plans can also be used as an emergency fund, since most employers allow hardship withdrawals.The next priority is to maximize contributions to HSA (Health Savings Account); individuals can contribute up to $3,850 and families up to $7,750 in 2023, commented McClanahan, founder of Life Planning Partners.
There may be some circumstances that could alter the assessment of HSA savings. McClanahan states that paying off a credit-card debt should take precedence over adding money to an HSA. Additionally, if a saver does not have an emergency fund, that should be the focus before contributing to an HSA, followed by establishing an emergency savings of three-to-six months. When there is extra money available, advisors suggest it be put towards IRAs, 529 plans, additional 401(k) savings or a taxable account.
HSAs are advantageous because they permit someone to recover money spent on qualified health-care expenses at any point in the future. Vanguard provides an example of this benefit: if one pays for braces in cash upfront, that amount can be repaid, tax-free, later on, even if it is for a non-medical expense such as college tuition or retirement costs. Nevertheless, the individual must have opened an HSA first and keep all receipts in order for the reimbursement to be legitimate. It is recommended to create a spreadsheet of unpaid medical expenses so that those records will be preserved and accessible when needed.
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