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How HSA DESTROYS Roth IRA and Traditional IRA in Retirement Investing

Are you spending the money in your HSA on healthcare expenses every year? Strike one.

Are you aware that you can invest the funds in your HSA? Strike three.

The HSA is the perfect investment account and it is hiding in plain sight. HSA stands for Health Savings Account but that is not how it should be used. Everyone is arguing about Roth vs. Traditional IRA while the HSA low key crushes both.

On the go? Watch my video here:

Most people don’t know that you can actually invest your HSA funds through most of the major stock brokerages.

As an example, I invest my HSA cash through Charles Schwab. I can buy individual stocks from publicly traded companies, I can invest in index funds or actively managed funds, and so much more.

Being able to invest this money for retirement and take advantage of all the available strategies that are unique to the HSA is huge.

What is an HSA?

The HSA is the only triple tax-advantaged account.

First, you can shield your income from taxes when you deposit funds into the HSA. This helps you by decreasing your tax bill which in turn leaves more money for you to spend or invest elsewhere.

Second, anything that goes on inside the account is shielded from taxes, like dividends and capital gains. In a typical brokerage account, if you want to sell one stock or share to buy another, you have to pay taxes if you made any money on that first transaction – which majorly slows down your gains over time.

Third, when you withdraw cash from the account for healthcare expenses it is tax-free. Not having to pay any taxes on capital gains or dividends can save you 15% or 20% depending on your tax bracket.

How does an HSA compare to an IRA?

The reason I compared the HSA to a spork is because it is like a Roth and a Traditional IRA combined – the spoon and fork.

First, the HSA is similar to the traditional IRA because both shield your income from taxes when you deposit. Putting your money in these accounts effectively lowers your income which results in lower taxes.

Second, the Roth IRA allows you to withdraw funds from the account tax-free just like the HSA when you spend the money on healthcare.

And finally, all three accounts, HSA, Roth, and Traditional allow you to buy and sell stocks and shares within the account without paying any taxes on dividends or capital gains.

Why an HSA is better

The huge tax savings and subsequent investment gains are the primary reasons the HSA crushes both traditional and Roth IRAs.

Shortly, I will get into a couple of examples using actual numbers so you can see how much money we are talking about.

Before then, let’s talk about 3 more advantages.

First, it is common for employers to make HSA contributions as a part of their compensation. Free money that compounds over time at a huge tax discount makes a huge difference.

Second, you can pull money out at any time, tax-free, for medical reasons. With a traditional IRA, if you pull money out for any reason, not only do you get taxed, but you also have to pay a 10% penalty.

Finally, and this one is a bit more work, you can reimburse yourself for medical expenses at any time. For instance, you can reimburse yourself at the age of 65 for an expense that you had when you were 25.

How much do we spend at 65?

One thing is for sure, you WILL have healthcare expenses in retirement. You are guaranteed to be able to take advantage of the tax-free withdrawals through an HSA.

According to CMS.gov, people 65 and older spend, on average, $22,356 per year on personal healthcare expenses. If you are in the 22% tax bracket, that comes out to an extra $4,918 per year in tax savings.

With that, I think it’s time to get into some more numbers. Let’s compare the returns from the three different accounts – HSA, Roth, and Traditional IRA.

First, I gotta list the assumptions that we will use going into this.

INVESTOR DEVON

Our hypothetical investor, Devon, is trying to decide the best way to invest an extra $3,000 in 2023 for retirement. Devon is 30 years old, makes $73,000 per year, and is in the 22% tax bracket.

Devon’s investment of choice is an S&P 500 index fund which has a historic average annualized return of about 9.5%.

However, after adjusting for inflation, the average annualized return drops down to about 6.6%.

Roth IRA

If Devon chooses to contribute that $3,000 to a Roth IRA at the age of 30, after 35 years invested in the S&P 500, Devon will have about $28,095.

Because Devon invested in a Roth IRA, 100% of this money can be withdrawn tax-free.

Traditional IRA

If Devon chooses to go with the Traditional IRA, then Devon can actually afford to invest $3,846. This is because of the 22% tax savings that you get from shielding your income in the traditional IRA.

If you invest $3,846 in a traditional IRA, then you pay exactly $846 less in taxes so it only costs you $3,000 to invest.

So Devon invests $3,846 in the traditional IRA in the S&P 500 over 35 years with historically average annualized returns then it will grow to about $36,017.

However, Devon will have to pay income tax on that money when it is withdrawn from the IRA. If Devon is still in the 22% tax bracket at the age of 65 then $36,017 turns into about $28,095 – the same as the Roth IRA.

If Devon is in a lower tax bracket at this age then the Traditional IRA would come out on top.

How HSA investing wins the day

Finally, Devon makes the correct choice and decides to invest $3,000 in the HSA.

Just like with the traditional IRA, Devon can invest $3,846 in the HSA because of the tax savings. The initial investment will also grow to about $36,017 over 35 years in the S&P 500 with historically average annualized returns.

But, the HSA pulls ahead on the withdrawal because of the additional tax savings.

If we also assume that Devon will have average medical expenses at the age of 65, then $22,356 can be withdrawn tax-free for those expenses and only the remaining $13,661 will be taxed. If we continue to assume Devon is in the 22% tax bracket, then the final amount comes out to $33,012.

And keep in mind, this is the gain from one year’s worth of investing.

Here is a nice mind map I made to help you visualize the tax-advantage differences between Roth IRA, Traditional IRA, and HSA:

Roth IRA vs Traditional IRA vs HSA

I hope I have convinced you to stop spending your HSA funds every year on your personal healthcare expenses.

Instead, you should consider viewing your HSA as a retirement investing account that should only be touched in a health emergency. Since you are only allowed to deposit a certain amount each year, you do not want to waste it.

Until next time!

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