Health Savings Accounts (HSAs) are our top funding priority, since they provide a triple tax benefit! Contributions to HSAs are tax-deductible, funds inside the HSA can grow tax-deferred, and distributions are tax-free to the extent used to pay for qualified medical expenses. Other distributions are subject to income taxes at current rates (up to 37% federally) plus a 20% penalty if withdrawn prior to age 65, unless due to death/disability.

In order to maximize your HSA benefit, we recommend making the maximum tax-deductible contribution each year, paying for medical expenses out-of-pocket (but keeping all receipts) to allow your HSA funds to be invested and grow tax-deferred, and then later taking tax-free distributions to pay for your medical expenses. Many of our tax and business planning clients have followed this strategy religiously and have HSA balances of $250,000 or more by the time they reach age 65 and enroll in Medicare.

The next step is to withdraw the maximum amount tax-free. As a general rule, you can receive HSA distributions tax-free to the extent that you incurred qualified medical expenses for yourself, your spouse, and dependents, since the date you established the HSA. We previously discussed creative medical expenses you can use to maximize the amount of tax-free distributions.