Are HSAs the Best Kept Secret in Retirement Planning?

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What if there was an investment vehicle that could help you save for retirement while lowering the cost of healthcare for you and your dependents? For the millions of Americans who qualify, a health savings account can be just that.

Like its name suggests, an HSA is a type of account you can use to pay medical expenses not covered by insurance. Only those on a high-deductible health plan (HDHP) are eligible, but the benefits of opening one can be substantial. Contributions, as well as qualified withdrawals, are exempt from federal taxes and state income tax in most parts of the country.

As long as you’re eligible, you can open an HSA through any bank that offers them and continue making the maximum annual contribution ($3,500 for individuals, or $7,000 per household as of 2019) until age 65 as long as you are on an HDHP. For your insurance plan to qualify as an HDHP, the deductible must be at least $1,350 per individual/$2,700 per household with out-of-pocket expenses capped at or below $6,750/$13,500.

While you do not have to be employed to open or contribute to an HSA, you cannot be claimed as a dependent on anybody else’s tax return. Some employers may allow you to fund the account pre-tax directly from your paycheck. However, contributions can come from any source, and would just be claimed as a deduction when you file.

Here’s how this type of account can fast track your savings plan for old age. With other retirement products like an IRA or 401(k), you either pay taxes upfront (Roth) or when you withdraw (Traditional). HSAs can help you stash for your golden years without the government taking their cut as long as you only pull money out for medical expenses. That is hardly a restriction if you consider that medical bills will likely be your biggest expenditure in retirement.

You should take care not to put in more than you can afford, however. Any amount you take out for non-medical purposes will be subject to both income taxes and a staggering 20% penalty tax. If you must tap your nest egg for funds, consider taking money out of other retirement accounts first. The penalty for early withdrawals from an IRA is only 10%. After age 65, withdrawals from an HSA for non-medical uses will still be subject to taxes, but won’t incur a fine.

Other than spending restrictions, the primary drawback to an HSA is that you must maintain a high-deductible health plan as your only insurance to continue making contributions. That means you will be responsible for paying a large chunk of your medical expenses every year before your insurance even kicks in. If an extenuating health condition comes up, you could find yourself forking over more money than you have in the account.

If you are already paying for medical expenses with a flexible spending account (FSA), you may be wondering if you even need an HSA. While both FSAs and HSAs allow you to pay for healthcare using pre-tax dollars, FSAs belong to your employer, which means unused funds stay with them when you change jobs. An HSA, on the other hand, is completely portable. It also allows you to sock more away. As of 2019, individuals can contribute up to $2,700 into an FSA, or $3,500 to an HSA.

With an FSA, you must declare before the calendar year how much you will contribute to the account, and anything you don’t spend by the deadline are forfeit. An HSA has no such restrictions; unused funds simply roll over to the next year. In fact, one of the major advantages to an HSA is being able to grow the fund by investing its contents like any other savings account. Once you open an HSA, you will only be eligible for a limited purpose FSA that can be used exclusively for vision and dental bills. This can still be highly beneficial if you plan to have those expenses since the money you didn’t spend from your HSA can be left in there to grow tax free.

HSAs are highly attractive investment vehicles for retirement given their multiple tax advantages. Not only do contributions lower your federal taxable income, you won’t be taxed on growth, or any withdrawals made for therapeutic expenses. Since some form of medical outlay is inevitable as we age, you can effectively treat an HSA like any other retirement account. For those on a high-deductible health plan, consider opening an HSA as a valuable complement to your retirement saving strategy.