Different types of investment accounts offer varying treatment from a tax perspective. Nearly every one of them only allows you to benefit from one side of taxation. I’ll go into the details of each of those in another post, but here’s a quick summary.
Pre-tax Retirement Investments
Typical 401ks, 403bs, 457s, and IRAs allow you to reduce your current year’s income which lowers your Adjustable Gross Income (AGI) and ultimately lowers the taxes that you need to pay this year. You can use these to try to land in a lower tax bracket, especially if you think you’ll be in a lower bracket in retirement. Unfortunately, you are required to pay taxes on the gains as well.
Post-tax Retirement Investments
Roth 401ks, Roth 403bs, and Roth IRAs do not give you any tax benefits up front. They do not lower your current AGI or lower the taxes you’ll pay this year. However, they do have the same contribution limits, which means you can effectively save more if you’re maxing out your contribution. The other huge benefit is that you don’t need to pay taxes on your earnings or your withdrawals for qualified distributions
Non-retirement Investments
Taxable or standard investment accounts don’t have either of those benefits. So in general, I recommend making sure that you’re using the retirement options for longer term investments before investing in a standard taxable account.
However, none of these can hold a candle to the Health Savings Account (or HSA for short).
HSAs offer a triple tax benefit.
- You contribute pre-tax income. This means that HSAs act like the first group of pre-tax retirement accounts. They reduce your AGI and the taxes you pay this year. This effectively means that if you are in the 24% tax bracket that it will only reduce your take home pay by $760 to contribute $1000 to an HSA. If you’re fortunate to be in the 32% tax bracket, you’d only reduce your take home pay by $680 to contribute $1000 to an HSA.
- Your money grows tax free. If you invest the money that you contribute to your HSA in stocks or bonds and it increases in value, you don’t need to pay taxes on any of those increases.
- You don’t pay taxes on withdrawals. Assuming you withdraw the money for eligible health care expenses, you don’t owe any money on the money you remove from the account.
This triple tax benefit is not available in any other investment which easily makes the HSA the best investment vehicle in America.
However, there are some requirements that must be met for you to be eligible to contribute for a given contribution year and limits to how much you can contribute.
- You need to have a high-deductible health insurance plan.
- You cannot be covered by another non-high deductible health insurance plan.
- There is a maximum amount that you can contribute each year. This varies year to year and also based on individual or family coverage. For 2021, the limits are $3600 for individuals and $7200 for family plans.
Stay tuned for tips on how to supercharge your HSA.
“Stethoscope and Money – Health Care Costs” by wellness_photos is licensed under CC BY-SA 2.0