Episode Transcript
Brenton: [00:00:00] It's open enrollment time for many people at their jobs, the period of the year where you pick the employee benefits you choose to use for the upcoming 12 months. And in this episode, we're going to tell you about an account that many people associate with health expenses that can actually be used as a secondary retirement account, a health savings account.
Let's get started.
Brenton: Hello, my name is Brenton Harrison of New Money, New Problems, and your host for the New [00:01:00] Money, New Problems podcast. October and November are open enrollment months for many people at their job. It changes depending on your employer, but for the typical person that we work with, October and November is the time of year where you have.
60 days to choose the employee benefits that you want to both come out of your paycheck over the course of the next 12 months, but more importantly, for you to use them over the course of the next 12 months. And for many people that go through the list and they kind of glaze over it because it's a really boring meeting with HR.
So they pick the first health insurance plan that comes to mind, a vision plan, a dental plan. They decide if they're going to pay for that extra life insurance or just take what the company owes them. And one area where they typically gloss over, or in many cases just don't pay enough attention to, are things like health savings accounts, flex spending accounts, and dependent care flex spending accounts.
If you've been following our platforms for a while, you know that I'm a huge fan of these accounts, and over the course of the next two episodes, we're going to cover why. In this episode, we're going to talk about health savings accounts in the next [00:02:00] episode. We're going to talk about dependent care, flex spending accounts and flex spending accounts, but I wanted to give health savings accounts its own episode because there are a number of tools and benefits associated with this type of account that many people are unaware of.
So let's start with what most people do know. Many people are already aware that a health savings account is a tool or an account where you can put funds aside in order to pay for certain eligible health expenses. And when you put it aside in that account, it has a number of tax benefits. Now we'll get to those tax benefits in a second, but before you even sign up for a health savings account, you need to be aware that in order to do so, you have to fundamentally change the health insurance plan that you have in addition to that HSA. If you're going to have an HSA, it has to be paired with something called a high deductible health plan.
Now a deductible is the amount of money that you have to pay towards your care before the insurance company kicks in. As an example, you might have a health insurance plan that has a 1, 000 deductible, a 2, 000 deductible, a 5, 000 [00:03:00] deductible. And in these instances, you're having to pay that amount towards your care before the insurance company will chip in and pay a percentage, or in some cases, all of the health expenses that come after that point.
So obviously if you have a lower deductible, you are on the hook for a lesser amount of your care before the insurance company kicks in. But the less you're on the hook for, the more you pay each month for the coverage. As an example, if you have a thousand dollars deductible for your health insurance, you're gonna pay a lot for your health insurance as compared to a $5,000 deductible, which would be considered a high deductible health plan. Because with that high deductible health plan, the health insurance company lets you take a whole lot of the risk before they have to come into the ball game.
So as you're listening to that description, you can identify the obvious pros and cons. The con to having a high deductible health plan is if you are in poor health, or if you have a child or a spouse that's in poor health, it's probably not a good idea for you to have a high deductible health plan because you likely will have to use your health insurance a good bit, you don't want [00:04:00] to have to pay more out of pocket before your insurance company kicks in, or just be taking all the money out of the HSA that you put in it for your future benefit In the first place. After the break, I'll tell you about some of the decisions that my family and I made as it pertains to a health savings account and the health of my family.
But that's the obvious con. You're on the hook for more of your care. Now, the pro is obvious as well, since you're on the hook for more of your care, if you don't use that care on a month to month basis, you are paying less for that high deductible health plan than you would for the other options your company may give you out of that portfolio of plans. So, the first potential benefit of a health savings account isn't even connected to the account itself.
It's actually a tertiary benefit that says if you use an HSA, you have to use a health insurance plan that might lower your monthly premium.
Now, let's get to the health savings account itself. The health savings account is like a shell. You put money into it, and just like a brokerage account, if you decide not to do anything with the money in that shell, it sits in [00:05:00] cash. When you put that money in cash, it has three different tax benefits depending on how those funds are used.
The first benefit is that the funds contributed to a health savings account are contributed pre tax, meaning that they come out of your check before taxes are assessed against what you earned.
We've talked about this in similar formats with pre tax retirement accounts, like an IRA or a 401k, where you put money in before it's taxed in exchange for paying taxes on the money when it's withdrawn in those accounts in the case of retirement.
As an example, let's say that you have a bi weekly paycheck of 3, 000 and you decide that you're going to put 200 every pay period into your health savings account.
Well, since it comes out pre tax, you would have that taxable income reduced from 3, 000 to 2, 800 before you have to worry about what's coming out of that paycheck. It lowers the amount of income on which you pay taxes.
The second tax benefit to an HSA has to do with not only the ability to invest the funds, but also the fact that the unused [00:06:00] dollars in an HSA roll over from year to year. This is the key difference between the flex spending accounts and dependent care flex spending accounts we'll talk about next week, where the unused funds at the end of the year do not roll over.
They are use it or lose it accounts. That's not the way it works with a health savings account. If you put 5, 000 into a health savings account, At the end of the year, you have 4, 000 left. That 4, 000 rolls over to the future year.
Now that's a great benefit, but one of the T's that goes uncrossed and I's that goes undotted many times when I look at people's HSAs is they don't realize that those funds can be invested, or if they realize it, they don't actually follow through on investing the funds themselves. They leave it in cash.
So I can see someone who has 10, in a health savings account that they've been contributing to for years, but the funds are still sitting in cash. Because you have to manually go in and pick the mutual funds or index funds that you're going to have those dollars go into, it's not something that will be automatically [00:07:00] enrolled like what you find in a 401k.
With a 401k, your employer is typically going to say, based on their age, we're going to put them in a target date fund for the year 2040 or 2045. With most HSAs, Your employer cannot assume that you want to invest those funds. You may prefer to leave them in cash. So if you don't make the investment decision, then it will sit in cash for as long as you leave it to do so.
Now, even if you make that decision, there's typically going to be a minimum amount that your employer is going to require you to keep in cash because it takes a while for investments to settle. As an example, if you have 10, 000 in a brokerage account that's invested in the index fund or an ETF, and you needed those funds, well, you first have to trade some of that index fund.
Then it takes a couple business days for those funds to settle, and after they settle, they can be transferred back to your account in cash. But because you might need your health savings account funds for an immediate health expense, there's typically a minimum amount, 1, 000, 2, 000, where your [00:08:00] employer requires you to keep that in cash and only the funds above those dollars will go into the investment of your choice.
But here's that second tax benefit coming into play for those funds that are invested as they grow in the market. You do not owe taxes on that growth from year to year. They are tax deferred.
We talked about this with the difference between retirement accounts and non qualified accounts like brokerage accounts. With a retirement account, if you have a thousand dollars that grows to a million dollars, there is no tax on that growth for the entire journey.
It's tax deferred. With a brokerage account, if it kicks off things like dividends and things of that nature, you do owe taxes on that growth from year to year. But with a health savings account, similar to a retirement account, the growth of those funds that are invested in the market are not taxed from year to year.
Now here's the third tax benefit. When you pull the funds out of a health savings account and use them for a qualified expense, they are not taxed either. If you're keeping track, that means that you put money in pre [00:09:00] tax and it wasn't taxed at that time.
As it grows on the market, you don't owe taxes on that growth, and if you pull it out for an eligible health expense, you don't owe taxes on those funds either. This is why some people refer to HSAs as having triple tax benefits. And there's typically far more things that you can use an HSA for than many people realize.
We'll put a link to some of these eligible expenses in the show notes. You can even find stores online like a Target HSA or FSA store, an Amazon HSA or FSA store, a Walmart HSA or FSA store where they have products on that page of the site that are all eligible for these types of accounts.
We'll put a couple examples of that in the show notes as well so you can see just how many things you can use in addition to things like doctor's visits to cover some of those eligible expenses. So those are the three tax benefits in the here and now for an HSA, but we haven't covered how it could be used as a secondary retirement account. We'll do that after the break, and I'll tell you a personal example of how my family and I decided whether we would or would not use an [00:10:00] HSA for our household.
[00:11:00]
Brenton: All right, so how can an HSA potentially be used as a secondary retirement account? One of the features of these accounts that is not often discussed or widely known is the fact that before age 65, you do have to use the funds in the HSA for an eligible health expense, but after age 65, you can use it for any expense, even if it's not related to your health. This turns it into a secondary retirement account because similar to a pre tax 401k, where you put aside dollars that have not been taxed and in retirement, you pay income taxes on the amount withdrawn, it would work the same way with an HSA.
If you put a hundred thousand dollars in the account and after age 65, you decide to pull out 25, 000 for a use of your choosing, you would pay income taxes as if you earned that 25, 000.
[00:12:00] Now this is a really cool feature and I'll tell you where it could fit in. We've talked in earlier episodes about the struggle that some people have to contribute or establish an emergency fund. And I've even gone to the extreme of saying that until you have an emergency fund, you should be really careful about contributing to things like your 401k. You have people who will be drowning in credit card debt, have not a dollar to their name, and they're still putting five or six percent into their 401k because they don't want to miss out on a 401k match. And I will counter with how good is that 401k match if you can't make it to retirement because you go bankrupt before then with no emergency fund and drowning in credit card debt?
Take a few months off, establish yourself, establish your reserves, and then go back to the 401k. Now with an HSA, this isn't something where you can say, Oh, well, you can do that immediately because remember you have to pair it with a high deductible health plan. So you don't want to put yourself in an even worse situation by signing up for a plan that requires you to pay more towards your health in the event of an emergency if you don't have those emergency [00:13:00] reserves.
But it is something when you're kind of climbing out of that period where you've established one month or two months or three months reserves, where now, since you have more of a cushion, you might see the HSA as a way to both free up cash by lowering your taxable income, by lowering your health insurance premiums, and also start to put aside money in addition to your 401k that says, Hey, right now I can use it to lower my taxes and use it for health.
If I don't use all those funds in retirement and my 401k ends up not being enough, there's another pool of resources that I can use to potentially benefit myself in those later years.
So it's more so an arrow in the quiver. You've heard me talk about using one arrow and shooting it at multiple targets. In many cases we come across families where they're trying to both pay for their children's college education and their current education. They're trying to pay for a family member who needs their financial help from time to time.
They're trying to make sure that they get a new house because they've outgrown the one that they're currently living in. They're trying to pay [00:14:00] down credit card debt. They might need a new car. They're trying to figure out whether they need to lease or own a car.
All of these things that are swirling around you financially, and you're also trying to make sure that you're saving enough for the future, is very, very hard to do. And when you look at the charts that tell you how much you should have in a 401k, many people, doesn't matter the income level, are way behind those projections.
So having an account that can be used to take one arrow and shoot it at multiple targets, like with an HSA, It's just yet another thing that you can add to give yourself the best chance possible to position yourself for your golden years. But that does not mean it's the right fit for everybody. I told you I would be transparent about the decisions that we make in my household.
My wife actually has an HSA available to her at her job. We use her health insurance. I'm an entrepreneur.
Trust me. It costs an arm and a leg to have a family health insurance policy without an employer who subsidizing some of that cost. As a matter of fact, when we were in our prior home, there was almost a [00:15:00] two year period where it cost us more for our health insurance than we paid on the mortgage on our condo.
It was just that expensive. So with her new employer, she gets a far more cost effective health insurance plan, but she also has the availability of a high deductible health plan paired with an HSA. So when we were picking out her employee benefits for the upcoming year, we had to make the decision.
Do we lower our health insurance costs but then take on the responsibility of paying more if we have to go to the doctor or our son has to go to the doctor or do we just pay a little more on the front end on a monthly basis so that those things are covered if we have a health expense. Now here's the rub. My wife and I rarely go to the doctor. She goes for annual checkups. I wish I went for annual checkups. I need to follow my own advice and start going for annual checkups.
But our health expenses for the two of us are not typically something that rises to the level of a consistent part of our budget. But our son, Brenton has asthma and he has allergies and he is at the doctor it seems every other month either in the emergency [00:16:00] room or getting a steroid or medications for his allergies or his inhalers and it's a significant monthly expense covering and managing those things on a yearly basis.
So when we had a conversation amongst the two of us, it was we have to go to the doctor all the time for him. We don't want to have to go to the doctor and have to pay all cash or have to pay the full price when we could have a 25 or a 35 copay. Yes, we have all the tax benefits of these HSAs at our fingertips, but for our peace of mind, it makes more sense to just go to the doctor and know that those expenses are already covered.
So I want to give you both sides of the coin. There are so many benefits that are associated with these accounts, but you have to have a knowledge of your situation. Is there someone in your house that takes expensive medications? Do you have to go to the emergency room or a specialist for a medical concern that's ongoing and is not going to go away in the next two or three months?
Is someone in your household pregnant or planning to be pregnant? All of those things can help color the decision of whether or not an HSA is for [00:17:00] you. But if it is right for you, there are multiple tax benefits and cashflow benefits that you can use to benefit yourself financially. I hope that this episode was helpful and illuminating. Next week we're going to cover the first cousins of health savings accounts, dependent care, flex penny accounts, and flex spending accounts.
I look forward to seeing you then.
