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Most people are familiar with the traditional accounts that can be used to help save for retirement, 401(k), IRA’s etc. but more and more people are utilizing health saving accounts (HSAs) to save for their retirement.
HSAs were not originally built as a way to save for retirement but because of their unique structure and benefits, they make the perfect tool to save when you have already maxed out other retirement accounts for the year.
What is an HSA and what makes it so great?
HSAs were originally created to help people enrolled in high deductible healthcare plans (HDHP) save in a tax advantaged account and pay for their higher deductibles and medical expenses. In order to be eligible to save in an HSA you must be enrolled in a HDHP. However, to use the funds already deposited in an HSA you do not have to be enrolled in an HDHP. That is because HSAs work similarly to a 401(k) in that they do not belong to the employer, they belong to the employee. This is part of what differentiates them from other healthcare accounts like FSAs and DCFSAs (flexible spending accounts and dependent care flexible spending accounts). That means you can change healthcare plans, move employers, be unemployed, or retire and the account will always belong to you.
Another important aspect that sets HSAs apart from other accounts is its triple tax advantage. Funds are deposited pre-tax, invested tax free, and used tax free! 1
HSA funds are deducted pre-tax directly from your payroll, though some allow for deposits outside of payroll deductions. They are exempt from federal income taxes and in most cases, state and local taxes. The funds that are deposited in an HSA also do not count towards your gross income for the year. Any funds deposited in your HSA can help lower your taxable income and even help to lower your tax bracket.
HSA funds can also be invested in the stock market, similar to a retirement account. And like a traditional 401k, the interest and gains that are made from those investments are not subject to capital gains or federal income taxes.
The third and strongest tax benefit comes when the funds are used. HSA funds are completely tax free when they are used for a qualified medical expense. The IRS has created a guide on what expenses are considered qualified and can be found here.
How to make it to retirement
Since HSA funds never expire you can accumulate and grow your HSA account over several years. In order to do that efficiently consider setting aside funds specifically to cover short-term medical expenses. If short-term medical expenses can be covered out-of-pocket, or from a portion of your HSA, the rest of the funds can continue to accumulate and grow tax free within your account.
There is also no time limit on when you have to file a claim for reimbursement. So if you have a medical expense that you are able to cover out-of-pocket and down the road you find that you need extra funds, you are able to file a claim for that old expense and be fully reimbursed tax-free. 2
Investing your funds
HSAs are unique because most have the option to allow you to invest your money in the stock market through stocks, bonds, etfs and or mutual funds. The funds that are not invested in the market will usually earn an interest rate that is comparable to a savings account. Both of these offer the opportunity for compound growth and compound interest.
Since HSA funds are a long term investment most financial professionals recommend taking a more conservative investment strategy than for a traditional retirement account like a 401(k) or IRA. To find the right investment strategy for you it is important to talk to a financial professional about your risk tolerance and goals for the funds.
Using your HSA in retirement
Professionals estimate healthcare costs to be one of the most expensive items that have to be covered in retirement. According to Fidelity’s annual Retiree Health Care Cost Estimate, a couple age 65 can expect to pay around $295,000 in medical expenses through retirement. That is part of why saving and growing and HSA can be advantageous once you are in retirement. The funds can be used tax-free to cover medical expenses even when you are no longer employed. The funds can also be used to pay for Medicare premiums for Part B and Part D and prescription drug coverage. It can also be used to cover any gaps in coverage should you retire before qualifying for Medicare or if you lose your job (they can also be used to cover COBRA premiums).
One of the biggest benefits of saving your HSA for retirement is if you are over the age of 65 you can use the funds to cover non-qualified expenses penalty free! 3 After the age of 65 your HSA works very similar to a traditional 401(k). You can use it on any expenses, like a vacation or to buy a car, and will only have to pay taxes just like a pre-tax 401(k).
1 HSA funds are tax free when used for qualified medical expenses. In some states they can be subject to state and local taxes. For specifics on your state and area contact a tax advisor.
2 To file a claim be sure you keep a record of the expense that meets the requirements of documentation for an HSA.
3 HSA funds used for non-qualified expenses under the age of 65 will be subject to taxes and a 20% penalty from the IRS.