Updated: Oct 26
If you are in the fortunate position of considering early retirement and are savvy about how you allocate your savings, you likely are already on a great path to accomplishing your goals. More than likely you are taking advantage of your 401(k)/403(b) or other retirement plan, a Roth IRA, and possibly utilizing a taxable brokerage account. What often gets overlooked is the benefits of an HSA or Health Savings Account. While commonly associated with healthcare expenses, HSAs offer a wide range of advantages that make them particularly appealing to individuals in their 20s and 30s. In this article, we will explore the numerous benefits of an HSA and why you should consider leveraging this powerful financial tool during this pivotal stage of your life. Below are 5 key points to consider with HSA utilization:
The most significant benefit of an HSA is the triple tax advantage it offers. Contributions made to an HSA are tax-deductible, which allows you to potentially reduce your taxable income when you make a contribution to one. Secondly, the funds within the HSA grow tax-free, allowing your savings to compound over time. The growth of the funds within the HSA are dependent on the amount saved and the length of time they are saved. Typically funds within an HSA accrue interest like a savings account, but some companies allow for investments, (discussed later on). Third, withdrawals used for qualified medical expenses are tax-free, making it a tax-efficient way to pay for healthcare costs.
For example, if you are in the 25% tax bracket and you make a $400 contribution to an HSA you could reduce your taxable income by $400, and reduce your overall tax bill by ~$100. Then you could accrue some interest on these funds, and later on pay for a medical expense with the funds + growth tax free. You can contribute up to $3,850 per year to an HSA or $7,750 per couple.
Building a Health Safety Net:
Your 20s and 30s are a time of increased responsibilities. You may be purchasing a home, moving, starting a family, and/or growing within your chosen career. You are also starting to see your retirement and investment savings grow and are well on your way to financial independence. When retiring early, health expenses and insurance is a significant consideration, and maximizing an HSA early can build up a solid financial foundation for taking care of health expenditures when retired, and can be a way to cover higher medical charges. Your HSA contributions continue to build year after year and you are not bound by income limits like with a Roth IRA.
Flexibility on closing the gap between Retirement and Medicare:
If you are aiming to retire early in your 50s, 40s or even earlier, you will likely need to be covered by an additional health insurance plan unless you are covered by a spouse’s plan. This can feel limiting and stressful as one may feel pressured to choose a plan with a higher deductible, or a plan may cost too much and can thwart a retirement decision. Having a solid bucket of HSA money can help bring flexibility and peace of mind when covering higher medical bills resulting from a high deductible health plan.
If you are more than 10-15 years away from retirement and starting your FIRE journey, consider investing options for your HSA. Some institutions that administer HSAs allow direct investments. As mentioned previously, saving over a long period of time into your HSA can help cover medical expenses during the gap between retirement and starting Medicare at age 65. Being able to participate in potentially higher earnings from market growth can create an exponentially better outcome as earnings are not taxed in an HSA.
An example of a common strategy here is to utilize an HSA with an investing option. Fund the HSA and keep a portion of the funds for immediate emergency health expenses. Then, aim to save additional dollars within a low cost fund consistent with your risk tolerance and timeline of planned usage of the funds.
Planning for early retirement is exciting, yet tricky, as it breaks the conventional norm and creates additional planning needs. With one of those additional planning needs being planning for unexpected health costs and expenses, an HSA is vital to a successful early retirement plan because of the aforementioned tax benefits, flexibility, and investment benefits.