An HSA isn’t just for health-related incidentals. It can be a powerful savings tool, too
Banking on a 401(k) to fund your retirement? For some, there are better ways to pay for one of the biggest retirement expenses: health care.
Health savings accounts (HSAs) have some unique features that can help sock away money for health expenses and add some flexibility around how and when you can get to your savings.
HSAs were introduced in 2003 to help people with high-deductible health plans (HDHPs) pay for health care. HDHPs have lower monthly premiums than other types of insurance plans, but higher deductibles and out-of-pocket costs.
For example, HDHP plans in 2020 will have a minimum annual deductible for individuals of $1,400, and $2,800 for families. Many people who opt for an HDHP are generally healthy and want the peace of mind of knowing that they’ll have coverage in the case of a medical emergency or unexpected diagnosis.
Enter HSAs, which come with some surprising and powerful financial benefits.
HSA Benefit #1: Major Tax Advantages
HSAs help you manage your medical costs. First of all, you contribute money to a special tax-free savings account. Even better, when you use the money to pay for eligible medical expenses—like doctor visits, lab work, prescriptions, eyeglasses, and dentist appointments—you don’t pay a tax penalty for withdrawing.
Plus, there’s no annual “use it or lose it” rule with an HSA, as there is with a flexible spending account (FSA). Your HSA funds remain available to you, year after year, until you spend them.
In 2019, you can contribute up to $3,500 per year to an HSA for yourself, or $7,000 for family coverage. This is usually done as a pretax payroll deduction, which means the money gets taken out of your gross pay, which reduces your taxable income.
Any non-payroll HSA contributions you make on your own are tax-deductible, too—you just have to claim them on your tax return. And starting the year you turn 55, you can also make catch-up HSA contributions, up to an additional $1,000 per year.
HSA Benefit #2: It Can Help You Grow Your Nest Egg
An HSA will help you stay on top of your medical bills right now. But you can also use it to build wealth, says Roy Ramthun, a health care and public policy expert and the founder and president of HSA Consulting Services.
You’re allowed to invest HSA funds in stocks, bonds, mutual funds, and the like, and any money you make from investing isn’t taxed. So, if you can afford to pay your health care costs another way, you can treat your HSA as an untouchable nest egg and let it grow for as long as possible.
That’s Ramthun’s strategy. “I’ve had an HSA for 14 years, and I’ve never taken a withdrawal,” he says.
You’re going to be spending a lot on health care when you retire, so access to easily liquidated cash will be a huge relief. “The projections I’ve seen are that couples are going to need around $300,000 for their health care expenses in their retirement years. And that’s after what Medicare covers,” says Ramthun.
Being able to pay for these costs with your HSA will save you a significant amount of money. Here’s why: If you dip into another type of retirement account, like an IRA (individual retirement account), you pay taxes when you withdraw the funds.
So, for example: Say you have a $1,000 hospital bill. If you pay for it with an IRA, you’ll need to take out about $1,250 to cover both the bill and the tax hit.
But you’re not taxed if you use your HSA funds for eligible medical expenses, so you’d only need to withdraw $1,000 to pay the bill.
HSA Benefit #3: Complete Flexibility
There’s no deadline for submitting a reimbursement claim to your HSA, so you can hang on to your health care receipts and wait to withdraw funds until it makes the most financial sense to do so.
What’s more, most retirement accounts require you to start taking minimum distributions—which are mandatory yearly withdrawals—when you reach age 70 and a half. That’s not the case with an HSA.
“You can leave the money in your HSA if you want,” Ramthun says.
Here’s why that’s beneficial in retirement: Taking distributions from a retirement plan can bump up your monthly income to a higher bracket, which can make your Medicare premiums go up, Ramthun explains.
Speaking of Medicare, once you’re on it, you’ll no longer be allowed to add more pretax dollars to your HSA. But you’ll always have access to the money that’s already in the account.
What happens if you decide to use your HSA funds for something other than health care costs? You’ll pay income tax on the money, plus a 20 percent penalty. But after age 65, that 20 percent penalty goes away, and you’ll just have to pay income taxes on the withdrawal, making it very similar to an IRA, Ramthun explains.
Do Your HSA Homework
If you’re interested in opening an HSA account, keep in mind that not all high-deductible health plans are HSA-eligible. Check with your employer or insurance company to confirm that you qualify.
Some health plans offer HSAs for their high-deductible plans, but you can also open one through some banks and other financial companies.
If you do qualify, Ramthun suggests that you put as much into it as you can. If your employer matches your 401(k) contributions, start there, because “that’s free money,” he says. “But once you’ve maxed out your employer’s matching dollars, the rest of your money should first go into the HSA until you’ve hit your maximum, and then to your other [savings and retirement] accounts.”
