Health savings accounts (HSAs) help you set aside money to pay for qualified medical expenses, but did you know they can also be a great tool for retirement planning? You can invest money stashed in an HSA in mutual funds and stocks, plus it offers valuable tax benefits—all of which make health savings accounts an ideal way to save up for inevitable medical expenses in retirement.
Retirement Planning with HSAs
High-deductible health plans (HDHPs) can be an expensive option for health insurance coverage, due to elevated out-of-pocket costs. That’s why they generally offer health savings accounts, which can help you cover some of the extra medical costs associated with HDHPs.
An HSA offers a hat trick of tax advantages: Contributions to your account are made pre-tax, lowering your taxable income today; investments grow tax free while they’re kept in the account; and withdrawals are free of income tax, as long as you use the money for qualified medical expenses.
Sound familiar? These advantages might remind you of the benefits you get with retirement plans like a 401(k) or an individual retirement account (IRA)—but they’re even better with an HSA, if you use it correctly.
“You aren’t taxed on either end if HSA withdrawals are qualified. It combines the best tax features of a Roth and a tax-deferred account,” says Brandon Renfro, a certified financial planner (CFP) and assistant professor of finance at East Texas Baptist University.
And like retirement plans, HSAs also let you invest your savings in mutual funds, stocks, exchange traded funds (ETFs) and other securities—which offer better growth potential than a regular savings account.
HSAs vs FSAs
Health plans with lower deductibles—and lower out-of-pocket costs—offer flexible spending accounts (FSAs). They offer similar tax advantages to an HSA, but with an FSA, you have to use the money or lose the money by the end of each year. You can’t roll over the funds. Not so with HSAs: You get the tax benefits and you can maintain a balance indefinitely.
Making regular contributions to an HSA with an eye toward covering medical expenses later in life should be a key part of your retirement plan. Fidelity has estimated a couple retiring in 2020 would need almost $300,000 to cover medical costs in their golden years. And this number will only rise over time as medical costs routinely outpace inflation by multiples.
Best of all, after you turn 65 you can use the funds for any purpose above and beyond medical expenses if you pay income taxes on the withdrawals. Before you turn 65, though, you must pay income taxes plus a 20% penalty on unqualified withdrawals.
How to Save for Retirement with Your HSA
If you choose to use your HSA to save for retirement, follow these tips to ensure you’re getting the most out of your account.
Reserve Enough Cash to Cover Your Deductibles
Since HSAs are only available with high-deductible health plans, you need to make sure you have enough cash on hand to pay your higher deductibles when you need medical care. Save the money in your HSA or in a high-yield savings account.
If you choose to keep funds earmarked for deductibles in your HSA, make sure it isn’t invested in tradable securities.
During a market downturn, you might be forced to sell shares of any mutual funds or stocks you own at a loss in order to pay for medical care.
If you’re especially concerned about covering medical costs in a pinch, consider raising the amount you keep liquid to be equal to your out-of-pocket maximum.
Invest the Extra Funds
Once you have enough liquid cash to cover your deductibles, invest the rest of your HSA funds. Unfortunately, most people with HSAs—including those who report they’re saving for retirement with an HSA—do not invest in stocks, bonds or mutual funds using their account, according to the Employee Benefit Research Institute (EBRI).
Your HSA provider may provide you with a range of different funds and securities as options. If you don’t like what you see, consider moving your funds to a provider with better choices. As long as you have an HDHP, you can open an HSA outside of the one your employer provides.
As with all retirement investing, carefully consider your time horizon. The number of years standing between you and retirement will likely dictate how aggressive or conservative you choose to be in your fund selection. If you’re looking for a hands-off approach, consider a target-date fund.
Save Your Medical Receipts
If you’re using your HSA to invest for retirement, you might choose not to use the funds to pay for medical expenses now. But it’s still important to track medical expenses now because they may help you make tax-free withdrawals from your HSA later.
HSAs have no clock on medical reimbursements, meaning if you have a saved receipt, you can pay yourself back for it even years after the initial expense.
“If your child had an emergency room visit years ago, you may reimburse yourself at any time from the HSA, as long as you have the receipt,” says Paul Mitchell, CFP and partner of Precision Wealth Partners in Delaware. “You can choose to pay all medical bills out of pocket, invest the HSA funds, then reimburse later with the HSA earnings from any tax-favored growth.”
Make Catch-up Contributions
Like other tax-advantaged retirement accounts, HSAs allow catch-up contributions as you approach retirement age. With an HSA, you can invest an extra $1,000 per year if you are 55 or older,. This brings HSA contribution maxes to $4,600 for an individual and $8,200 for a family.
Consider an IRA Rollover
If you have money in a traditional IRA, you can make a one-time transfer of funds into a health savings account through a process known as a rollover. It gives some of your IRA funds the triple-tax-free benefits of an HSA, assuming you used the money for current or past health-related expenses. If you used them in any other way, you would effectively have a traditional IRA by another name.
A few important notes about an IRA-HSA rollover:
- You are able to do this one time in your life.
- You must remain in a HDHP for 12 months after this rollover takes place.
- You are limited to rolling over no more than your annual single or family contribution max for the year, minus any money you’ve already contributed to your HSA that year. In other words, your IRA rollover is less a rollover and more making your HSA contribution for the year with your retirement account, instead of your wallet.
With that in mind, it would generally only make sense to do this kind of rollover if you cannot or were not planning on maxing out your HSA in a given year. From a retirement planning perspective, it would be better to contribute as much as you can to both an HSA and an IRA to benefit from all of the tax advantages you can.
Save What You Can Before Medicare
When you’re no longer in a HDHP, you cannot contribute to an HSA. This means that once you’ve started taking Medicare, you can no longer contribute to an HSA, even through an IRA rollover.
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