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Do This Before Maxing Your TSP

Federal Employees

Contributing money to your Thrift Savings Plan is a good thing, actually a great thing! But there is one account that should probably be funded before maxing TSP.

It makes a lot of sense to contribute to a Health Savings Account (HSA) prior to contributing the maximum to your TSP. An HSA is an account designed for individuals with a high deductible health plan (HDHP).

Why do an HSA?

They are triple tax free! Compliance hates it when advisors say things like free or tax free, but Health Savings Accounts (HSAs) are literally triple income tax free. You don’t pay taxes on contributions, money grows income tax free and comes out income tax free if it’s used for healthcare expenses.

Don’t stop contributing to TSP!

Notice that I said to start an HSA before maxing your TSP. It is important that all federal employees contribute 5% to TSP to get the maximum match. Then and only then is it acceptable to make contributions to an HSA.

How much can you contribute? The maximum contribution to an HSA for 2021 is:

  • Self only - $3,600
  • Family - $7,200

Here are a number of things you should know about HSAs.

  1. You don’t have to use your contributions every year. Many people get HSAs confused with a Flexible Spending Account. While the two are similar, they are NOT the same. Health Savings Accounts don’t require you to use your contributions every year like FSAs do. Your contributions can stay in the plan from year to year.
  2. No FICA taxes are paid on HSA contributions. FICA (Federal Insurance Contribution Act) taxes are paid up on earned income up to a limit of $128,700. Employees contribute a total of 7.65% of income to FICA. Employees pay FICA on all 401k contributions but not on HSA contributions that are deducted from your paycheck.
  3. You don’t pay any taxes! All HSA contributions are pretax, and withdrawals are tax free if used for qualified medical expenses. Again, pretax dollars that can be withdrawn tax free! 
  4. HSA contributions can grow. Most HSAs will allow you to invest your contributions in mutual funds and exchange traded funds. Investing the funds can help with tax deferred growth in your account.
  5. HSA contributions can be used for retirement income. If your contributions don’t get used for health-related expenses, you can use your HSA to provide retirement income. Once you turn 65 you can make withdrawals and pay taxes just like you do from an IRA.
  6. You can name a beneficiary. An HSA will pass on to your named beneficiary at your death, but the rules are a little different than they are for an IRA. The ideal scenario is to name your spouse as beneficiary so that the spouse can use the HSA for their own medical expenses (they don’t need a high deductible health plan to be able to use funds from the HSA).
  7. You can delay taking distributions out tax free. One clever way of allowing your HSA more time to compound and getting tax free income in retirement is to delay distributions. If you can pay health expenses out of pocket while you are working, it may be beneficial to save your receipts and take tax free distributions once you retire. For example, if you have accumulated $30,000 in qualified health expenses while working, once you turn 65 you could take the $30,000 out of your HSA income tax free.

If you haven’t looked at them before, this could be the year to look at a high deductible health plan and an HSA.

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