The words health savings account may not conjure up thoughts of relaxing on the
beach, traveling the world, or gardening in your backyard full time.
But maybe they should.
Because of its potential tax benefits, a health savings account, or HSA, can actually be a
powerful retirement savings vehicle if you plan ahead.
Let's talk about how HSAs typically work, and then discuss how to use one to potentially
boost your retirement savings.
HSAs allow you to set aside untaxed money each year to pay for medical costs now and
in the future.
Many employers offer access to HSA-enabled health plans.
However, you can also set up an HSA on your own.
Either way, to be eligible to make an HSA contribution, you need to be enrolled in a
High-Deductible Health Plan one with low monthly premiums but high, out-of-pocket deductibles.
The main benefit of HSAs is that they allow you to take advantage of tax savings in three
ways.
First, contributions are essentially untaxed.
For an HSA provided through your employer, contributions are typically deducted pretax
from your paycheck.
Or, if you're on your own, they're tax-deductible.
However, the IRS does set an annual limit on contributions.
So keep that in mind, especially if you have more than one HSA.
Second, some HSA account providers allow you to invest your contributions once you reach
a certain balance.
The investment choices in an HSA are often similar and as flexible to those available
in other retirement accounts.
Earnings in an HSA account aren't taxed, so your investments can compound more quickly.
Lastly, you may make tax-free withdrawals to pay for qualified medical expenses.
So, basically, if you use your HSA only for medical expenses, you can contribute, grow,
and spend this money without ever paying taxes on it.
This is what makes HSAs one of the most tax-efficient investing accounts around.
But keep in mind, any money withdrawn for nonmedical expenses will be subject to regular
income taxes, and if you're younger than 65, you'll also pay a 10% penalty.
Another benefit of HSAs is they're portable, like an IRA.
This means whether you leave your job, change health insurance providers, or retire, your
money can go with you.
You can even pick a different HSA provider to transfer your HSA funds to, if you don't
like the one provided by your employer.
Now that you understand how an HSA works and its benefits, let's discuss how it can actually
help with retirement planning.
Because you're not obligated to spend the assets you've placed in your HSA, you could
use them later in retirement to cover medical costs.
According to the U.S. Bureau of Labor Statistics, households run by individuals 65 and older
spend an average of $500 a month on medical expenditures alone, so having a source of
tax-free funds can be a lifesaver.
Even if you're lucky enough to have low medical expenses during retirement, you can
use an HSA like a traditional retirement account after you turn 65.
This means you can make withdrawals for nonmedical expenses without a penalty, but you'll be
required to pay income tax on those funds.
Now let's look at a few things you should be aware of while considering if a health
savings account is right for you.
First off, an HSA for retirement only works if your medical expenses are low.
The High-Deductible Health Plans that make you eligible for an HSA may require greater
out-of-pocket costs, especially if you visit the doctor often.
HSAs are designed for you to set aside money to pay for those higher out-of-pocket expenses.
If you have high medical expenses over the years, you may not accumulate enough to invest
for retirement.
Another factor to consider is although HSAs can help you grow your money by avoiding taxes,
HSAs are subject to fees for account maintenance and the investments themselves, which can
eat into earnings.
And, of course, the underlying investments themselves are subject to risks, including
loss of principal.
So if your circumstances allow, setting up an HSA, making the maximum contribution permitted
each year, and allowing the funds to grow while not touching them for short-term medical
expenses could make it easier to pay for medical expenses during retirement.
And once you're 65 or older, you may use those funds for nonmedical expenses without
a penalty.
However, that money would then be subject to income tax.
Retirement is your time to sit back and enjoy yourself.
And an HSA may help you get your finances in order so you can relax during your golden
years.