IRAs and HSAs
After getting together my full 2005 Roth IRA contribution, shortly before making the contribution I realized that I could instead use the contribution to completely pay down one of my two remaining credit cards.
Getting myself further out of debt in this way, is appealing to say the least. On the other hand, if I don’t make my contribution for 2005 now, I’ll never make it. I’ll have lost the opportunity permanently. So I looked into it a bit, the card I’d be paying off has a balance of slightly over 4000 dollars. It’s interest rate is 12.99%. If I pay the account off today, it will save me somewhere in the neighborhood of 400-500 dollars. In contrast if I make the contribution, assuming an annualized return of 10% the amount will grow to be worth close to 30000 dollars, in 21 years. Knowing this it makes sense to me to take the hit from the interest today, knowing that by the time I’m ready to retire this decision will have made me a tidy sum. But maybe I’m looking at this wrong, what do you think?
I’m not sure how many of you are familiar with HSAs, so I’ll give a brief, general overview. HSAs are Health Savings Accounts, they’re used in conjunction with high deductible insurance plans. Contributions to these account are pre-tax, and are capped at the deductible of you insurance plan, so this amount can change from year to year based on your insurance.
At any time you can withdraw money from the account to pay for any medical expense, tax free. Once you hit age 65 you can make withdrawls for non-medical expenses without penalty, paying only taxes on the withdrawls. However if you make withdrawls for non-medical expenses before this you’re gonnah get hit with a penalty in addition to the taxes.
While it’s nice to be able to pay for medical expenses in this way, the downside is that you don’t have access to the money you save in this manner, plus theres the opportunity cost to doing this, you’ve lost control of the money, it won’t be working for you, right?
Not really, it turns out that most of the companies offering these accounts will pay you 3-4% a year for the privelege, that will beat inflation most of the time but it’s still not great. However, and here’s the interesting part, not all of the companies do this. Some of the companies allow you to invest in mutual funds with theses accounts, and still others will even allow you to invest in stocks.
So, is it useful or desireable, to treat and exploit HSAs as yet another tax advantaged retirement account? I don’t know, but it will be something I’ll be looking into as time goes on.
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Frank, is there a middle-ground option with your credit cards? It goes something like this:
1. Pay off your credit cards. That’s like getting 13% for your money right there.
2. Over the next year, use the money that you would have spent making payments on those cards to make other investments. If you don’t have other retirement accounts to contribute to, just start an online brokerage account.
Pros: You make the instant 13% and you can still invest some money that will build towards that $30k. You also get to manage the money directly, which is fun.
Cons: You lose whatever tax advantage you will have with the Roth IRA. This is okay if you weren’t expecting to max out all of your retirement accounts in 2006 (just move the money up one year). But if you are considering maxing out your 401k, IRA and whatever, then you’ll have to pay taxes on the earnings.
I’m not sure if I would play it this way exactly, but I would definitely consider it.
I was under the impression that one could only have an HSA in conjunction with a high-deductable health care plan.
I like HSAs because I’m young and healthy, but they are not for everyone. See my post about HSAs for what I think about them.
I did mention that HSAs are used in conjunction with high deductible savings plans, sorry I wasn’t clear in that they are only available with them.
I agree with the young and healthy comment as well. As a result my health care costs are going to be lower, and the HSA would be much more like just another retirement account. Plus the lower monthly premium offered by plans like this would allow me to sock a few extra dollars into the account as well.
However the more I think about it, the more I realize that until I can fully max my 401k and Roth each year, consistently, using the HSA as a retirement investment vehicle is probably not even a consideration that deserves debate.
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[...] 4/3/2006 Carnival of Personal Finance (representing IG: Frank’s Article on IRAs and HSAs [...]
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