Health savings accounts (HSA) are a versatile savings vehicle. As a medical savings account, they can help reduce your overall healthcare costs now. They can also double as an additional retirement savings vehicle.
What is an HSA?
The HSA is a medical savings account that can only be used in conjunction with a high-deductible health insurance plan but offers triple tax-free advantages. Contributions to the account are made on a tax-free basis, earnings on the account grow tax-free and withdrawals to pay for qualified medical, dental and related costs are tax-free.
The opportunity for pre-tax contributions can offer an additional tax break that could be even more valuable with some of the changes arising from the 2017 Tax Reform, including limiting deductions for state and local taxes and increasing the level of the standard deduction.
Unlike flexible spending accounts (FSA), a different popular medical savings account frequently offered by employers, funds left over in an HSA can be carried over from year-to-year. That’s where the ability to use the HSA as another retirement savings tool arises.
How the HSA Works in Retirement Savings
The ability to carry HSA funds over if not used in the current year plays a big part in utilizing this account for retirement savings.
One strategy is to pay out-of-pocket medical expenses from other sources while working and let the funds in the HSA grow to cover retirement medical expenses such as Medicare, qualified long-term care policies and other medical and dental expenses subject to the rules for qualified expenses.
Another source of funds to help cover the rising cost of healthcare can mean the difference between a comfortable retirement and one that is not as financially solid as you might like.
This is a significant amount for anyone heading into retirement. If you experience some significant health problems these numbers could be higher. And remember this figure doesn’t include the cost of long-term care if needed.
Many HSA providers offer the opportunity to invest the funds in the account in investments like mutual funds and others in a similar fashion to an IRA.
Advantages of the HSA
An HSA can offer another pre-tax retirement savings vehicle for those saving for retirement in addition to a 401(k) and an IRA, especially for those who are maxing out their contributions to these accounts each year.
Money in an HSA can be withdrawn tax-free to cover a whole host of eligible expenses, including: (2)
- Medicare premiums
- Eligible medical and dental expenses not covered elsewhere
- Flu shots
- Eye exams and lenses
- Guide dogs and service animals
- Insurance premiums for COBRA coverage
- Travel expenses related to essential medical services
- Psychiatric care
- Various prescription drugs
- Wheelchairs and artificial limbs
- Qualifying long-term car insurance premiums and costs
Once you are covered by Medicare you can no longer contribute to an HSA account. If you continue working past age 65 and are covered by your employer’s plan, you could still contribute to an HSA as long as you choose the high deductible insurance option.
However, once you reach age 65, you can make withdrawals from your HSA account penalty-free for any purpose just like an IRA account. You will be liable for any income taxes due just like with an IRA account if the withdrawals are not to pay for qualified expenses. Prior to this age, withdrawals for reasons other than paying for qualified medical and dental expenses will incur both a penalty and income taxes.
Another benefit of using an HSA in your retirement savings strategy is that the accounts are not subject to required minimum distributions—the money in the account can remain invested and will grow on a tax-free basis if the money is eventually used for qualified medical expenses, and tax-deferred if used for other purposes. This can be helpful for both retirement and estate planning purposes.
If you have access to one, consider a high-deductible health insurance plan and an HSA account. The HSA is a versatile account, covering qualifying expenses now if needed, and offering another retirement savings option for those who can cover their out-of-pocket medical costs from other sources. Additionally, the current tax benefits can be beneficial for many taxpayers as well.