Although created to make healthcare more affordable and expand freedom in personal healthcare decisions, Health Savings Accounts (HSAs) can also play a significant role in saving for retirement. Due to their multiple tax advantages, generous contribution options, and valuable investment opportunities, HSAs can be used to supplement retirement accounts.
HSAs and Healthcare
First and foremost, of course, HSAs exist to help pay for qualified medical expenses. Only those enrolled in high-deductible healthcare insurance plans – those with deductibles of at least $1,300 for individual coverage or at least $2,600 for family coverage – qualify to contribute to an HSA. As with Flexible Spending Accounts (FSAs) sponsored by employers, HSA contributions are deducted in partial, equal amounts from each paycheck. Funds can then be withdrawn at any time to pay for eligible healthcare expenses.
HSAs and Saving for Retirement
Beyond healthcare needs, though, HSAs can act more like an IRA or 401k retirement account. Money left in an HSA at the end of the year is not lost. Instead, it automatically carries over and continues to grow tax-free until the participant withdraws it. When the account holder reaches age 65, funds withdrawn for non-medical expenses no longer incur a 20 percent penalty; those withdrawals are taxed at the participant’s current tax rate, just as with traditional retirement accounts.
Even so, HSA funds used for major medical expenses after age 65 retain their tax-free status. Instead of withdrawing money from an IRA or 401k to cover significant medical expenses and paying tax on the distribution, HSA funds can cover those costs tax-free.
Three Tax Advantages Help Balances Grow
HSAs offer a “triple-tax-advantage” that helps now with savings for healthcare expenses and later for potentially wider use in retirement:
- Tax-deductible contributions. All funds deposited into an HSA account are pre-tax, which lowers the participant’s total taxable income.
- Tax-free withdrawals and gains. As long as they are used to pay eligible medical expenses, HSA withdrawals are not taxed. Interest earned and investment gains are also tax-free.
- Tax-deferred income. All taxes on any unused HSA balance is deferred until the participant withdraws funds at age 65 or older. If withdrawn then for a non-qualified expense, funds are taxed as regular income, usually at a lower rate and without penalties.
Similar to retirement accounts, HSAs have annual maximum contribution limits. For 2017, the limits are $3,400 for individuals and $6,750 for families (for 2018, annual limits will increase to $3,450 and $6,900, respectively). If a participant can’t afford to contribute the maximum amount, HSAs allow spouses, parents, and friends to make contributions. Employers who offer HSA plans are also allowed to make contributions.
Another benefit for HSA account owners approaching retirement are ‘catch-up’ contributions. Beginning in the year they turn 55, HSA owners who maintain enrollment in a qualified HDHP can begin making account contributions of up to $1,000 above the annual limit. This raises the total annual contribution limits for 55+ account owners to $4,350 and $7,750, respectively.
Investing Your HSA Funds
HSA accounts act like a basic savings account, paying minimal interest; however, they also allow investing the money for greater returns. Keep in mind, HSA providers usually require a minimum account balance in order to qualify for investing. Once balance hits that threshold, investing in mutual funds offers an effective way to add to retirement savings.
HSA accounts offer a safe and tax-effective tool for creating a larger retirement nest egg for those with relatively low healthcare costs who invest unused HSA funds wisely. When saving for retirement, don’t forget to include HSAs if you qualify.