Even up to the tax filing deadline for the prior year, it is still possible to make contributions to individual retirement arrangement (IRAs) and health savings accounts (HSAs) for that year. For 2017, this means you have until April 17, 2018 to contribute.
On the other hand, 401(k) and 403(b) accounts must be made through employer payroll deductions, so you cannot go back and contribute for the prior year to receive the tax advantages. You can go through your employer’s HR or payroll department to start making contributions on your next paycheck, however.
If you have received a windfall (e.g., a tax refund!) or just learned about retirement accounts, you can make retirement contributions for the prior year in January–April of the next year. Typically, you would want to max our your IRA first and then your HSA.
Individual Retirement Arrangements (IRAs)
For an IRA in 2017 or 2018, you can contribute up to $5,500 per year per person, or $6,500 per year per person if you ended the year at Age 50 or older. (You must have had earned income of at least the amount of your contribution.) There are income limits—in 2017, your adjusted gross income must have been below $118,000 if single or $186,000 for you and your partner if married to qualify for these maximal contribution amounts.
You open and contribute to an IRA on your own, not through your employer. Contribution limits to IRAs are in addition to what you are allowed to contribute to 401(k) or 403(b) accounts and HSAs. I use Vanguard for my IRA, although there are many others.
There are two types of IRA contributions: traditional and Roth. Traditional IRA contributions reduce your gross income on your tax return, but you pay income taxes on your gains at the time of withdrawal (e.g., retirement). Roth IRA contributions do not reduce your income on your tax return, but you do not pay income taxes on your gains at the time of withdrawal. The limit of $5,500 or $6,500 per year is aggregated (combined) between your contributions to both types of accounts.
If you have already filed your income tax return for the prior year, you would have to file an amended return to realize the tax savings from contributing to a traditional IRA for the prior year. However, because Roth IRAs have no immediate tax benefit, the IRS does not require paperwork or an amended return to contribute to one. This means you could contribute to a Roth IRA up to April 17, 2018 even if you filed your tax return in January. (The tax deadline varies by year and is often April 15.)
IRAs, like 401(k)s, 403(b)s, and even HSAs, are just a tax-advantaged wrapper for various types of savings accounts, bonds, or investments. In fact, you can pick what to do with your money, and change what you are doing with it without penalty. For instance, you could shift your retirement accounts from stocks toward bonds as you get older, to reduce risk. Because these accounts give you the opportunity for tax-free gains, just socking your IRA into a certificate of deposit (CD) is a very bad move in the long run. Investing for the long run in index funds of the entire US stock market, and perhaps a portion in the international stock market as well, will produce better returns. In fact, as your time horizon lengthens, somewhere around 10–20 years the probability of such stock investments beating the returns of CDs, Treasury bills, and bonds approaches 100%, and returns only get better beyond that.
Health Savings Accounts (HSAs)
The Mad Fientist has a great explanation of HSAs that I recommend reading. HSAs are special because it is actually possible to not pay income taxes on income contributed at all—not when the money goes in, not on the interest or capital gains, and not when the money is withdrawn to pay for or reimburse qualified medical expenses. Due to bizarre tax rules, it is even lawful to hold medical receipts for many years before reimbursing yourself as a distribution from your HSA. In the mean time, your HSA can be picking up tax-free capital gains by being invested in the Vanguard Total Stock Market index fund or a similar fund.
Contributing to an HSA is only allowed if you have health insurance, and the health insurance that you have must be a high deductible health plan (HDHP). However, if you have an HDHP, you can contribute to an HSA even if you have high income and are ineligible to contribute to 401(k)/403(b)s or IRAs. Contribution limits for 2017 are $3,400 for individuals and $6,750 for families, with an additional $1,000 allowed if you are Age 55 or older. To open an HSA for the prior tax year, you would either need to have not filed your taxes yet, or file an amended return after the contribution is made.
One aspect the Mad Fientist does not cover is where to house your HSA. You cannot do it at Vanguard. The Bogleheads wiki has a nice overview of various HSA custodians you might choose from. Unlike with IRAs or taxable investment accounts, HSAs tend to have more paperwork requirements and fees.
The HSA Authority is a nice one I helped set up for my parents recently, not mentioned in the Bogleheads wiki but discussed elsewhere on their forums. It has a $36 annual fee on your account, plus the expenses of whatever investment funds you choose. They have Vanguard index fund options as well as some less desirable funds with high expenses. It is a lot of hassle to open an HSA with the HSA Authority—you must fill out multiple forms to fax or mail, including notarizing an affidavit, writing checks to fund for the prior year (they will not take a bank transfer if funding the prior year), and first putting at least $1,000 in your HSA (actually a checking account) before you qualify to invest the money by filing an investment authorization form. Then, you are free to self-manage your investment through their online banking platform. When you file your taxes you would then go through the prompts in TurboTax or other software regarding HSA contributions, which would reduce your adjusted gross income for that tax year.
Other HSA custodians like HealthEquity have high fees and should be avoided. I believe they are taking 0.40% of your portfolio per year on top of a monthly fee… any such arrangement is ridiculous and becomes quite awful as you put more money in your HSA. Another item to watch for is fees on individual trades or investments—some HSAs charge as much as $25 for each action taken on your account, such as investing an amount in a Vanguard fund, moving to another fund, or changing custodians. Although unfortunate, this can be tenable as long as you are contributing the maximum amount in a lump sum each year to one index fund that you don’t touch. Simply stated, there is no easy or cheap option for HSAs. Nonetheless, because the tax benefits are huge, HSAs are definitely worthwhile if you qualify (have a high deductible health plan) and have the money to spare.
While before Age 65, there is a 20% penalty to withdraw from your HSA if it is not a qualified health expense, after Age 65, the penalty goes away and all you have to pay is income taxes on the total amount withdrawn. Therefore, if not used for health expenses, the HSA becomes similar to an additional traditional IRA or traditional 401(k) after Age 65, which is still advantageous to have.
Learning about and starting your IRA and HSA sooner, rather than later, is critical to reaching financial independence earlier, with less taxes paid and more money to spare. The same can be said for 401(k) or 403(b) contributions (403[b] is the non-profit equivalent of 401[k]), which have much higher annual limits of about $18,000. In fact, starting early is also key because if you succeed in your career and become a high earner later in life, you won’t be eligible to contribute to these accounts anymore (even with an HSA, you will probably be ineligible if your employer offers benefits). However, your existing contributions from prior years will remain and continue to grow, even if you become a high earner later.
Of course, to really leverage the power of these accounts you must be willing to invest in an index fund encompassing most or all of the stock market, for the long term, resisting the suicidal urge to withdraw your money when the market goes down. Long-term index fund investments, along with frugality and moderate or high income, are the recipe for financial success.
The ideas presented here should not be taken as financial, investing, tax, or legal advice. Richard Thripp earns no revenues for any hyperlinks or recommendations in this article.