Most financial products that are created as tools for retirement savings, like IRAs and 401(k)s, offer some type of tax advantage that allows you to get the most bang for your buck. A Health Savings Account (HSA) is a type of account that provides tax advantages to offset the cost of health care expenses. So what does that have to do with retirement?
An increasing trend among smart savers is to use the benefits of HSAs to boost their retirement savings. It is a method of saving that isn’t immediately obvious to most people, but it is something everyone should be aware of.
Here is what you need to know:
HSAs were not developed for retirement savings. They are tax-exempt or custodial accounts available in conjunction with high-deductible health plans in order to offset the cost of health-related expenses. Deductibles and premiums go hand in hand when it comes to health plans. Plans with higher deductibles typically have lower premiums, and vice versa.
People who do not foresee needing many medical and health-related services often choose plans with high deductibles in order to save money overall on their monthly premiums. If they do suddenly have a large expense, however, they may be faced with meeting the high deductible. Furthermore, if they need to visit health professionals on a regular basis, such as for sick visits or lab testing, many services may not be covered or may be only partially covered.
HSAs were designed to be paired with HDHPs to offset these concerns. Even if no single big medical expense arises and you don’t suddenly need to begin seeing the doctor on a frequent basis, the little day-to-day and month-to-month costs of caring for you and your family’s health can add up significantly over time. Therefore, using money from an HSA to cover qualifying health expenses is always a great way to boost your savings, making it a smart choice for people looking to stash away more in their retirement savings.
The tax-preferred status of an HSA provides benefits in three ways. First, the contributions are tax-deductible or, instead of deducting the contributions, you can contribute pretax funds. Second, the interest and earnings in these accounts grow tax-free. And last, when you use the money for qualifying medical expenses, the distributions are tax-free.
If you do not have a lot of health expenses, you may not think this type of account is useful to you, but the retirement benefits go much further than simply allowing you to save money as medical expenses arise. An important aspect of HSAs is the fact that you don’t have to use the funds during the year you put them into the account. Many people do not realize this because there have been similar accounts, known as Flexible Spending Accounts (FSA), that did not allow funds to roll over.
“Participants can contribute to an HSA for decades and let their contributions build up over time,” states Ryan Guina for U.S. News & World Report Money. “These funds can also be invested in stocks, bonds and other instruments.”
HSAs are similar to IRAs and 401(k)s in many ways, which is why they have gained the attention of savvy retirement savers of all ages. Just like with retirement accounts, a contribution limit is set for each individual and family. There is also a provision in place for older individuals who need to catch up on their savings, which allows them to contribute more after they reach a certain age.
If you are in a position to max out the contributions on your retirement accounts, then the real benefit of the HSA comes into play. While it is true that you can withdraw the money from your HSA only for approved health-related purposes without incurring a tax penalty, that rule goes away once you reach retirement age.
“After age 65, you can withdraw money to pay for nonmedical expenses, but the funds will be taxed as income (similar to an IRA),” states MP Dunleavey, former editor in chief of DailyWorth.com. “So if you use your HSA funds only for qualified medical expenses you can net a triple tax break: You get the pretax benefits of an IRA, the tax-free withdrawal benefits of a Roth and the tax-free growth benefits of both. Otherwise, after age 65 you can spend the money on anything, but that money would be taxed, similar to IRA withdrawals.”
This means that you don’t have to stop saving once you max out your IRA and 401(k). Triple tax benefits plus the ability to stash away more money in savings mean that HSAs are a valuable tool for your current budget and your future finances.
