Have you ever been envious of someone because they have a health savings account (HSA)? If not, it may be because you haven’t heard how an HSA can supercharge your retirement planning.
Here’s how it works, and why more people are investing in their HSAs with an eye toward the future.
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What is an HSA?
An HSA is a tax-advantaged savings account, available only to those with high-deductible health plans. The account is designed to cover qualified medical expenses; these include prescriptions, copays, mental healthcare, dental and vision services, and some over-the-counter purchases. It can even be used for certain insurance premiums, like those for COBRA or Medicare.
If your high-deductible health plan covers only you, you can contribute $4,300 annually to an HSA. If it covers your family, your contribution limit is $8,550. Plus, if you’re 55 or older, you can add a catch-up contribution of $1,000.
A pretax way of saving
Like most employer-sponsored retirement plans, contributions to an HSA are pretax, meaning you don’t pay taxes on the income. Interest and investment earnings grow tax-free, and withdrawals to cover qualified medical expenses are also tax-free.
Here are a few of the finer details regarding HSAs and taxes:
- Qualified medical expenses: Withdrawals for qualified medical expenses are always tax-free, no matter how old you are.
- Under age 65: If you’re under age 65, withdrawals from your HSA for nonqualified medical expenses are taxed as ordinary income. You may also be subject to a 20% penalty on the amount withdrawn.
- 65 and older: If you’re 65 or older and make a withdrawal for something other than a qualified medical expense, the 20% penalty no longer applies, although you will pay ordinary income tax on the withdrawal.
Again, withdrawals for qualified medical expenses at any age are tax-free.
Use it now or use it later
HSAs are nothing if not flexible. Owning an HSA means determining how you want to manage the funds. You can use it solely to cover current medical expenses, or you can save it for later.
Unlike funds in a flexible spending account (FSA), the money left in your HSA can be rolled over from year to year. Imagine you begin contributing to an HSA this year and spend the next 20 years contributing $5,000 annually. At the end of those 20 years, there will be $100,000 in the account.
However, there’s a way to make the account worth far more than $100,000. Like other HSA owners, you could invest the money. Most HSA providers allow you to invest your HSA funds just as you would a 401(k) or IRA, giving your account the potential to grow dramatically.
Let it grow
Let’s say your high-deductible healthcare plan covers your family, and you contribute $8,550 to an HSA each year. You spend the first $3,550 on medical expenses and pay for any additional expenses out of pocket.
You invest the remaining $5,000, earning an average annual return of 7%. Instead of being worth $100,000 after 20 years, your account could be worth almost $205,000, more than twice as much.
Cover retirement-related expenses
Although you can’t contribute any more money to your HSA after you’ve enrolled in Medicare, you can spend your retirement years using funds from the account to cover essential medical expenses. Here are some examples:
- Medicare Part A premiums (though most people get Part A for free)
- Medicare Part B premiums
- Medicare Advantage premiums
- Premiums for Medicare Part D prescription coverage
- Long-term care insurance premiums
- Deductibles and copayments for medical products and services
Alternatively, you have the option of spending HSA money after reaching age 65 on nonmedical expenses with no penalty. You’ll pay taxes at your ordinary tax rate for any such withdrawals (just as with most retirement plans), but you get some extra flexibility to decide where the money will be most helpful.
It’s tough to find much about HSAs to dislike. In fact, they may be attractive enough to tempt you to enroll in a high-deductible health plan.