Have you ever heard something and thought it sounded too good to be true? Sure, we all have – like there’s a pot of gold at the end of a rainbow, $17 worth of Shiba Inu coins will make you a millionaire, NBC’s TV series Chuck is making a comeback, or never having to pay taxes… ever. Maybe I am the only ‘Nerd Herder’ here that wishes the TV series Chuck would make a comeback, as I have recently been binge watching it (again) while working out and have even gotten my kids to watch it with me. But wait, maybe I digress and that is a topic for another blog…
Taxes, and not having to pay them – is that even possible? With anything? I assure you it can be. There are two rare unicorns of tax-free investments where taxes are never paid if done right – contributions are made pre-tax, and money can be taken out without paying taxes. Double tax-free! There is one that many are probably familiar with, but many are not taking advantage of as they didn’t realize the true benefit of it, and another that very few have probably heard about.
HSA: The Unicorn of Healthcare Savings
Baby steps – let’s start with the easy one. Health Savings Account (HSA) – you have probably heard of this as an additional benefit to a High Deductible Health Plan (HDHP). HDHPs are often popular amongst healthy individuals and families with lower medical expenses, as the cost of the plan is typically lower because they have a higher deductible. As long as your medical expenses are low, or you have savings available to pay up to the higher deductible should something arise, these often make great sense. Let me be clear, I am in no way making recommendations on health plans here, but just highlighting the benefits of one type in particular. To offset the cost of the higher deductible, an HSA account is generally available. You may think that it is just added work to keep track of saving into a separate account that can only be used for medical expenses (even including items such as cold medicine, band aids, and such), and then subsequently not being able to have liquid access to that money for other things, is more hassle than it is worth. But I assure you that the juice is worth the squeeze in this case.
An HSA allows you to contribute pre-tax dollars to an account that can be used to pay for qualified medical expenses. These expenses include doctor visits, prescriptions, dental and vision care, and even over-the-counter medications. The best part? Any money you withdraw for qualified medical expenses is tax-free. It’s like having a personal healthcare fund that grows tax-deferred and can be used tax-free.
But what if you don’t have high medical expenses? If you don’t have high medical expenses during your working years, we all know that could change when we get older, so an HSA is a great place to start saving for medical expenses we will likely incur in our twilight years.
Once you turn 65, you can also use your HSA funds for any purpose without incurring the typical 20% penalty. However, you will still owe ordinary income taxes, on any withdrawals not used for qualified medical expenses, which is very similar to how a traditional IRA is treated. One strategy that people will utilize is to contribute additional savings beyond their IRA or 401(k) savings to an HSA account.
The current maximum contributions for an HSA in 2026 are $4,400 for an individual, or $8,750 for a family. If you are over 55, individuals can contribute an additional $1,000 per year.
One alternative to an HSA is deducting medical expenses from your taxes. However, you can only deduct expenses that exceed 7.5% of your adjusted gross income (AGI). This means that if your AGI is $100,000, you can only deduct qualified medical expenses beyond $7,500. And let’s face it, most people find it easier to claim the standard deduction rather than itemizing deductions.
So, while deducting medical expenses is an option, it’s often less beneficial than contributing to an HSA. With an HSA, you’re not just saving on taxes for the current year, but you’re also investing in a tax-free account that can grow over time.
The Retirement Unicorn: Tax-Free Income
Speaking of standard deductions, let me introduce you to our second unicorn that provides tax-free retirement income! In retirement, many people do not have as many deductions on their taxes as they did before retiring. If they still have a mortgage, their payments are mostly principal and not interest. Charitable contributions in retirement are often made by volunteering their time and not with their pocketbooks (and unfortunately the IRS does not count this). So, much of the standard deduction is still available as a deduction on their income.
As is the case with most retirees, your income will likely come from a combination of social security, a pension (decreasingly so), and a traditional tax-deferred IRA – all of which can be taxed. Did you know up to 85% of your social security can be taxable? That is a topic for another post, but important in improving your likelihood of success in retirement. Of course, the traditional IRA is our focus here, specifically the portion which fits into the standard deduction each year and taxes are not paid on. That is the trick – calculating the appropriate size of your traditional tax-deferred IRA so that your Required Minimum Distributions (RMDs) each year fit within your Standard Deduction.
To take it a step further down the road of tax-free retirement income, if, like me, you think taxes are going to have to go up in the future, you can strategically convert the rest of your IRA to a Roth IRA, leaving enough remaining in your IRA for your RMD each year to just fit within the standard deduction. It also may not be prudent to convert everything to Roth in a single year as that will likely bump you into a high tax or IRMAA bracket, but to instead convert portions over multiple years.
Every person and situation is unique, so care must be taken to look at your own scenario to determine the appropriate strategy for you, but if your income is coming from a Roth IRA, which is tax-free, as well as an RMD that fits within the standard deduction, all of your income during retirement can be tax-free, allowing you to better plan for retirement, and not have your income affected when taxes go up.
Investment vehicles that are never taxed are rare finds, and taking advantage of them and other efficiencies within your financial plan can better help you to achieve your financial and retirement goals. HSAs and RMDs from your Traditional IRA that fit within the standard deduction truly are the unicorns of the financial world, as they offer incredible opportunities to help save money and reduce your tax burden. If you want to learn more about how to harness the power of these financial unicorns, reach out to us.
We’re here to help you achieve your financial goals. Of course, it’s important to note that everyone’s financial situation is unique, and there’s no one-size-fits-all approach. Consulting with a financial advisor can help you determine the best strategy for your specific goals and circumstances. If you want to talk with a financial advisor who focuses on retirement planning, fill out our contact form and somebody will reach out to you shortly for a complimentary Clarity Strategy Session.
