Why Most People Are Doing HSAs All Wrong

There is a benefit in the tax code that goes largely ignored. The holy grail of financial planning is an investment that gives you a tax deduction on the front end, lets your money grow tax-deferred and allows you to take that money out tax-free. In the Power of Zero paradigm that usually means a combination of Roth conversions and LIRP conversions.

For most married couples, the ideal balance of the tax-deferred bucket is between $300,000 and $350,000. In that situation it qualifies as the holy grail of financial planning.

There is a second way to accomplish the same tax-free holy grail: through an HSA or health savings account. When you put money into your HSA you get a deduction, the money grows tax free, and when you take it out for qualified medical expenses you don’t pay any taxes at all.

David breaks down the two scenarios of either having an HSA or not having an HSA in the event of a healthcare issue. With an HSA, healthcare expenses are not taxed.

Most people go wrong with their HSA by not using all three tax advantages. They take advantage of the tax deduction on the front end and take the money out tax-free, but they’re not taking advantage of the tax-free interest in investment earnings.

HSAs are designed to grow the investments inside of them. Instead of using the HSA as a slush fund for smaller, out of pocket medical expenses when you’re young, let your precious tax-free dollars experience the ability to grow in a tax-free environment. Use that money when you’re older after it’s grown and those medical costs are usually higher.

Keep all your receipts for medical expenses along the way. There is nothing that says you need to get the reimbursement from your health savings account in the same year that you make the purchase. Let your HSA accumulate tax-free and build steam.

It’s also important to keep the receipts in case you get audited. You will need to prove that you had a qualified medical expense and that you paid for it.

With just a little tweak, you can use all three tax advantages that the HSA confers. Pay for your medical expenses out of pocket now and let that money accumulate tax-free.

People don’t think of the HSA as the tax-free vehicle that it is, just like a Roth IRA. We are always told that we are either going to be taxed on the seed or the harvest, but with the HSA you are taxed on neither the seed nor the harvest. The problem is people don’t let their HSAs grow.

If we can all make a little tweak to how we treat our HSAs, we’ll have another tax-free bucket to take advantage in the Power of Zero paradigm. There are lots of tax-free streams of income out there and we’re not taking advantage of all of them like we should.