One of my favorite things about contributing to my 401(k) is watching my net worth increase. Every dollar that goes into this tax deferred account is subtracted from my taxable income and tax sheltered until I withdraw. As long as I withdraw fewer dollars during retirement than I make now, I’ll pay less taxes on those dollars. As a result, my net worth grows even faster.
But this year I maxed out the $18,000 contribution limit pretty fast. As soon as that happened I thought, where else can I contribute? Luckily, I have a health savings account (HSA) through my employer.
Triple Tax Free
An HSA is a triple tax sheltered account that’s usually available through a high deductible health insurance plan. The 2016 HSA contribution limit for individuals is $3,350, which means maxing out a 401(k) and an HSA gives you a total of $21,350 of tax sheltered dollars for the year.*
But that’s not all, an HSA also grows tax free and allows tax free distributions on qualified health-related expenses. For example, you can pay for visits to the doctor or even contact lens solution with tax free dollars from an HSA.
How to Hack the HSA
The best way to hack your HSA, though, is to (1) max out your contributions, (2) invest it all in low cost index funds and (3) pay for qualified health expenses with non-HSA dollars (such as through a rewards credit card). This way your HSA not only grows tax free, you can get credit card points and reimburse yourself with HSA dollars at any time!
For instance, let’s say you maxed out your HSA and paid $2,000 for trips to the doctor, dentist and optometrist this year with a Chase Sapphire Preferred Card. You invested the full $3,350 in your HSA in a total market fund like VTI. You’d then get 2,000 credit card points and tax free growth in connection with any gains (both capital and dividend) on VTI. Then three years later you can withdraw $2,000 from your HSA and pay for anything you want. You can even use your HSA debit card (if you have one) and withdraw that money from an ATM and it’ll be tax free. Of course, you’ll want to keep your $2,000 in medical receipts** so that if you ever get audited, you can prove that you’re reimbursing yourself for qualified medical expenses.
And that’s pretty much it! You get a triple tax sheltered account to add to that already wonderful 401(k). Just remember that if you don’t ever reimburse yourself, the funds will continue to grow tax free until retirement. In that case, you’ll be able to make tax free withdrawals after age 65.
*Depending on your modified adjusted gross income, you may also qualify for IRA contributions.
**Don’t like the hassle of keeping receipts? You might have to anyway. Regardless of whether you’re paying straight from your HSA or reimbursing yourself later, the IRS may still ask for proof that these were qualified medical expenses.