Health Savings Accounts (HSAs) help make healthcare more affordable and provide more freedom in personal healthcare decisions. They can also play a significant role in saving for retirement. Due to their multiple tax advantages, generous contribution options, and valuable investment opportunities, HSAs effectively supplement traditional retirement accounts.
HSAs and Healthcare
HSAs can be used to pay for qualified medical expenses, but only for those enrolled in high-deductible healthcare insurance plans (HDHPs). These plans hold deductibles of at least $1,500 for individual coverage or at least $3,000 for family coverage. As with employer-sponsored Flexible Spending Accounts (FSAs), HSA contributions are deducted in equal amounts from each paycheck throughout the plan year. These funds can then pay for eligible healthcare expenses at any time.
HSAs and Retirement Savings
In addition to healthcare needs, HSAs can act like an IRA or 401k retirement account. Money left in an HSA at the end of the year automatically carries over and grows tax-free until the participant withdraws it. If withdrawn for a medical expense, there is no tax or penalty on the withdrawal. If withdrawn for a non-medical expense, the withdrawal is taxed and incurs an additional tax penalty of 20 percent.
Once the account holder reaches age 65, HSA funds used for major medical expenses retain their tax-free status. Funds that are withdrawn after age 65 for non-medical expenses no longer incur a 20 percent penalty but will be taxed at the participant’s current tax rate, just like with traditional retirement accounts.
Three Tax Advantages Help Grow Balances
HSAs offer a “triple tax advantage” that helps with savings for current healthcare expenses and potentially offers greater use in retirement:
- Tax-Free contributions. All funds deposited into an HSA account are pre-tax, lowering the participant’s total taxable income.
- Tax-free withdrawals. HSA funds used to pay eligible medical expenses are not taxed. In addition, interest earned, and investment gains are also tax-free.
- Tax-free gains. Interest earned and investment gains on unused balances are tax-free until withdrawn, and if used for qualified medical expenses, always remain tax-free.
Similar to retirement accounts, HSAs have annual maximum contribution limits. For 2023, the limits are $3,850 for individuals and $7,750 for families. If the account owner needs help contributing the maximum, the IRS allows spouses, parents, and friends to contribute to another person’s HSA. Employers who offer HSA plans are also permitted to make contributions.
Catch-Up Contribution Provision
Another benefit for HSA account owners approaching retirement is the ‘catch-up’ contribution. In the year an HSA owner turns 55, they can begin making account contributions of up to $1,000 above the annual limit as long as they continue to be enrolled in a qualifying HDHP. This provision raises the total annual contribution limits for 55+ account owners to $4,850 and $8,750, respectively.
Investing HSA Funds
HSA accounts act like basic interest-bearing savings accounts. However, most HSAs also allow investing funds for greater returns. Remember that HSA providers usually require a minimum account balance to qualify for investing.
HSA accounts offer a safe and tax-effective tool for expanding your retirement nest egg, especially for those with relatively low healthcare costs who invest their unused HSA balance wisely. When saving for retirement, remember to include HSAs if you qualify.