By CASEY TINIUS / CFP®
With each passing year Health Savings Accounts are becoming more and more popular. After all, don’t you wish you could pay for all of your personal expenses with pre-tax money? HSAs are the most tax-efficient savings/investment vehicle on the market today. You get a tax deduction for your contributions, the funds grow tax-deferred similar to an IRA, and distributions are tax-free provided they are used for healthcare expenses.
But what if there was a way to make this vehicle even more efficient?
The Shoebox Strategy is a method that can boost your HSA into overdrive and help you achieve an even more tax efficient retirement. The strategy is most beneficial to those maxing out their HSA contributions on an annual basis. This can be done in 3 easy steps;
- Pay medical expenses out of pocket and keep receipts (in a shoebox, hence the name)
- Invest your HSA dollars
- Reimburse yourself for past medical expenses
Let’s break down each step in a little more detail.
- Paying for medical expenses out of pocket is often easier said than done. It is sometimes hard to rationalize using cash when you have more than enough money sitting in your HSA. Cash flow can also be an issue- - therefore, if you can’t afford to pay your medical expenses out of pocket you will not benefit from this strategy.
- Once you accumulate a few thousand dollars in your HSA you will have the ability to get a portion of the funds invested. Most plans will require you to keep at least $2,000-$3,000 in cash, but any funds above that amount can be invested in the plan’s investment options. Provided you do not plan on using the funds in your account, HSAs should be invested more aggressively due to their huge tax advantages.
- The best part about the Shoebox Strategy is that there is no time-limit to reimburse yourself for past medical expenses. You could pay for a medical expense tomorrow at age 30 and choose to take a tax-free reimbursement at age 65. Just make sure you have a receipt for any reimbursed expenses in case you get audited.
To wrap things up, here is a quick example of how powerful this strategy can be:
Let’s assume I max out your HSA at $7,300 for the next 32 years until age 65. At a modest 5% return I would have around $575,000 in my HSA at age 65. Assuming I pay my family’s medical expenses out of pocket and they averaged $5,000 per year over those 32 years, I would be able to take a $160,000 tax-free reimbursement. The other $410,000 remaining in my HSA could be used for medical expenses throughout retirement.
If cash flow allows, supercharge your HSA by using the Shoebox Strategy.