Investors need to earn a return on their assets. To many, that goal is secondary to not losing the money they have. Protecting the nest egg can be achieved through investment selection, appropriate timing, and legally avoiding taxes. One way to mitigate tax liability is by putting some of your investments into a Heath Savings Account (HSA).
Regarding tax avoidance, think of the HSA as an IRA (Individual Retirement Account) on steroids. The following is excerpted (but modified) from “Don’t Run Out of Money in Retirement: How to Increase Income, Avoid Taxes, and Keep More of What is Yours.” I will italicize the most significant parts in case you want to skim it:
An HSA enables you to deflect up to $8,300 of income per year (2024 limit) from taxes. An HSA is unique because you benefit from both the tax-deductible contributions and the federally tax-free distributions. The HSA allows you to use untaxed money for costs such as deductibles, copayments, and other medical expenses.
An HSA is unique in the world of tax-preferred investment accounts because it is currently the only type of account that allows you to benefit from both tax-deductible contributions and tax-free distributions. That differs from, for example, traditional IRAs or 401(k)s, which can reduce your taxable income for the year in which you make the contribution but require you to pay the taxes when you make withdrawals.
Unlike IRAs or 401(k)s, which require distributions, you can keep money in an HSA for as long as you want. The money is available for you to spend on qualified medical expenses either now or way into the future. That means the money in these accounts can grow tax-free for a long time. If the HSA has not been used by the time the owner dies, the surviving spouse can gain control of the account and maintain the same benefits. Because of those unique tax advantages, some people pay out of pocket for medical expenses that arise early in retirement so that the money in the HSA will continue to compound and grow.
The qualified expenses for which you can use an HSA include deductibles, copayments, and other medical expenses. (For a full list, see IRS Publication 502.) The tax break on those expenses effectively lowers your overall healthcare costs.
To qualify for an HSA, you must be enrolled in what is considered a high-deductible health plan, which for 2024 means a deductible of $1,600 for self-only coverage and $3,200 for family coverage. (IRS Publication 969 details exceptions.)
The contribution limit for 2024 is $4,150 for individuals or $8,300 for couples. There is a catch-up provision for people who are age fifty-five or over.
An HSA gives you the potential to accumulate significant savings to pay for medical expenses during retirement, free of income tax. And it’s convenient. Most HSAs issue a debit card to pay for those qualified expenses, or you can pay in cash and reimburse yourself.
There are two additional HSA tax-avoidance and income tricks for you to be aware of. One is the qualified HSA funding distribution. If you are confronted with high medical expenses and have an insufficient balance in your HSA, you could transfer assets from your IRA to cover qualified medical expenses. You can transfer up to the amount of the annual HSA contribution limit (that amount includes any standard contributions). Under current law, a taxpayer can take advantage of moving IRA assets to a more tax-advantaged HSA account once. Additionally, if the IRA account holder is of age, the HSA funding distribution is counted toward satisfying the required minimum distribution.
Words of wisdom from Charlie Munger
On November 28, 2023, at age 99, Charlie Munger passed away. Charlie, the right-hand man of famed investor Warren Buffet, was an astute capital allocator, too. Charlies gave Warren credit for investment advice that helped their company, Berkshire Hathaway, build a legendary investment portfolio. Charlie counseled, “A great business at a fair price is superior to a fair business at a great price.” Here are some other quotes and considerations from Charlie that may help you with investing and in life. The first two are a couple of Scott Little’s favorites:
- “The world is not driven by greed. It’s driven by envy. I have conquered envy in my own life. I don’t envy anybody. I don’t give a damn what someone else has. But other people are driven crazy by it.”
- “The first rule of a happy life is low expectations. If you have unrealistic expectations, you’re going to be miserable your whole life. You want to have reasonable expectations and take life’s results, good and bad, as they happen with a certain amount of stoicism.”
- “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.” Charlie made this comment regarding financial instruments. It reminds me of conversations with investors who say that their financial advisor doesn’t charge them; just because you don’t write a check doesn’t mean you’re not paying.
- “You’d be amazed at how much Warren reads—at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.” Because of this comment, and a similar one from Warren, I read The Wall Street Journal, paid research, and industry rags every day. Rarely do I experience an “aha” moment where I know action is required. However, accumulated knowledge makes it easier to make tough, logical decisions, even when fear or greed makes it difficult.
- “The worshipping at the altar of diversification, I think that is really crazy.” I’ve always said that diversification for the sake of diversification is dumb. I get that there is comfort in a portfolio with little volatility, so you buy something that zigs when something else in the portfolio zags. But why on Earth would you want to hold onto a failing investment for a prolonged period? Besides, as Charlie said about volatility …
- “Using volatility as a measure of risk is nuts. Risk, to us, is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return.”
- “We recognized early on that very smart people do very dumb things, and we wanted to know why and who so we could avoid them.” Billions of people have lived through thousands of years. Many of their success and failures have been documented. It’s a dataset that provides anecdotes and statistically relevant information on how to dodge hubris and sidestep big mistakes.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
