TLDR: HSAs offer an unparalleled opportunity for long-term tax-advantaged wealth growth and are particularly well suited for young high-income earners.

Are you a young high-income earner looking to reduce taxes and build long-term wealth? Look no further than the Health Savings Account (HSA), an exceptional financial tool. HSAs offer triple tax advantages and the potential for substantial growth, making them an attractive option for those aiming to maximize their wealth in an extremely tax-efficient manner. In this post, we’ll dive into why HSAs are so appealing for young high-income earners and provide concrete examples to illustrate their benefits. First a note. To fund an HSA, you’ll need to be covered by a High Deductible Health Plan (HDHP). For this post, I’ll assume you have HDHP coverage. Let’s get started!

Triple Tax Advantages

HSAs boast three remarkable tax advantages, making them an extremely powerful tax reduction and wealth accumulation tool:

1.kPre-Tax Contributions

Contributions to an HSA are made with pre-tax dollars, meaning they are deducted from your gross income before taxes. Let’s assume you and your spouse are both 35 years old and you collectively earn $400,000 annually. You decide to start contributing $8,300 per year to your HSA. This reduces your taxable income to $391,700. This results in tax savings not only on federal income tax but if you live in a state with a state income tax, excluding California and New Jersey, you also avoid state income tax. If we assume these are New York state residents, they would avoid an additional 6.85% state tax for total up front tax savings of 38.85% or $3,225 per year!

2. Tax-Free Growth

HSAs allow you to invest your savings just like you would in an IRA and like an IRA, these savings grow tax-free. For this 35-year-old couple, this could mean up to four or even five decades of compound growth without incurring any taxes on dividends, capital gains, or interest, regardless of how high their incomes grow.

3. Tax-Free Withdrawals

When you use HSA funds for qualified medical expenses, those withdrawals are also entirely tax-free. This is true whether you withdraw the money in a month or in 40 years.

Allow me to repeat. You contribute money pre-tax. The money can be invested and grow tax-free for decades and then those funds can be withdrawn 100% tax-free for qualified medical expenses. In other words, the IRS never touches a dime of that income or subsequent investment growth!

Long-Term Wealth Accumulation & Flexibility

HSAs offer the potential for long-term wealth accumulation and can act as a valuable retirement savings tool:

Unique Benefits

Unlike Flexible Spending Accounts (FSAs), HSAs are not subject to a “use-it-or-lose-it” rule. The funds in an HSA roll over from year to year, and again, you can invest them for long-term growth. Additionally, HSAs are portable, meaning they remain with you even if you change jobs or health insurance plans. This flexibility allows you to maintain your savings and continue making contributions as long as you’re covered by a High Deductible Health Plan. Another benefit of HSAs is that upon reaching age 65, you can withdrawal the money for non-medical expenses and avoid the dreaded 20% penalty. You would simply pay income tax on the withdrawal. This gives you the flexibility to basically turn some or all of your HSA into a Traditional IRA if you determine that you don’t need the money for healthcare costs in retirement.

Ongoing Contributions & Compound Growth

In 2024, the maximum annual contribution is $8,300 for married couples, but this amount usually increases each year. If we expand on our earlier New York state residents earning $400,000 per year and assume 15 years of contributing $7,750, this couple would have contributed a total of $124,500 and they would have saved approximately $48,368 in income taxes. After accounting for the tax savings, they are essentially only on the line for a total of $76,132 in contributions. If we assume they invested the money in the HSA and got an 8% annualized return, their account would have grown to approximately $225,363 at the end of the 15 years.

The Results

To illustrate the full long-term wealth building potential of HSAs for younger high-income earners, let’s continue with our example:

After 15 years of making $8,300 annual contributions, our couple is now 50 years old and their HSA has a balance of approximately $225,363. However, being savvy financial folks, they know that according to Fidelity’s most recent annual study, the average 65-year-old couple that retires in 2022 will need approximately $315,000 after taxes to cover their healthcare costs throughout retirement. Accordingly, the couple decides to let the money continue growing tax-free in the HSA until they retire at age 70. Assuming that same 8% return, at age 70 the couple’s HSA balance will have grown to approximately $1,055,068! That’s right, over one million dollars they can use to cover healthcare expenses throughout their retirement, such as Medicare premiums, long-term care costs, or out-of-pocket expenses not covered by insurance – all 100% tax-free. By doing so, they can preserve their other retirement accounts, such as 401(k)s or IRAs, and allow the dollars in those tax-advantaged accounts to keep compounding longer.

Conclusion

For young high-income earners focused on reducing taxes and maximizing long-term wealth, HSAs present an unparalleled opportunity. The triple tax advantage, long-term investment potential, portability and flexibility, and the option to use it as a retirement savings alternative all contribute to its appeal. By taking advantage of these features, individuals can accumulate significant tax-free savings over time and enjoy the financial security and flexibility that HSAs provide.

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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Robert Stromberg, and all rights are reserved. Read the full Disclaimer