Before starting my current job, I didn’t really know much about Health Savings Accounts and the many benefits they offer. An HSA is a triple tax-advantaged medical savings account that is available with certain high-deductible health plans. If you have access to one of these plans and are willing and able to handle the high deductible, an HSA can be a great way to boost your retirement savings. Here are some reasons why I’m such a huge fan of these accounts.
Contributions are tax-deductible
Any contributions you make reduce your taxable income. The limit for HSAs in 2017 is $3,340 for individuals and $6,750 for families. There is also a catch up contribution of $1,000 available for those 55 or older. Being in one of the higher tax brackets, anything I can do to lower my tax burden and save some money is a plus. For instance, if my effective tax rate was 30%, maxing out my HSA contributions could potentially save me about $1,000 in taxes. Also, contributions are “above the line” deductions, and there are no income limits or phaseouts.
Investment earnings grow tax free
You can usually link your HSA to an investment or brokerage account. My account is with HSA Bank, which I then linked to a brokerage account through TD Ameritrade. Here I have access to many different investment options, such as stocks, index funds, and ETFs. Any investment earnings grow tax free, much like a 401k or IRA. Also, an HSA is not a “use it or lose it” account. Any unused funds carry over to the following year, allowing your money to compound and grow with time.
Withdrawals are tax-free if used for qualified medical expenses
These can be taken at any time without the prior approval of the HSA trustee or the insurance provider. Withdrawals are income tax free for qualified medical expenses. Some examples include dental care, eye exams, and eyeglasses. You can even use the funds to help pay for insurance premiums and deductibles. If not used for qualified medical expenses, withdrawals are subject to income tax. If you make withdrawals before the age of 65, you’ll have to pay an additional 20% penalty. This penalty is waived once you reach 65 or if you become disabled at the time of withdrawal. In this way, an HSA behaves much like a traditional IRA.
You don’t need to use HSA funds when you incur medical expenses
If you’re able to pay for any medical costs up front, you don’t have to use money from your HSA. As long as you keep good records and save your receipts, you could potentially hold off on withdrawing HSA funds for any medical expenses until later. This keeps your money in the account and allows it to grow and compound for even longer. For instance, say I incur $5k in medical expense one year but am able to pay completely out of pocket (thanks, emergency fund!). I could save all of the receipts from these expenses and, at a later time, withdraw $5k from my HSA tax-free! Since I’ve already paid the original medical expense, I could technically use the money however I want.
There are no Required Minimum Distributions (RMDs) for an HSA
Unlike a traditional IRA, an HSA is not subject to RMD rules. That means you could technically keep your HSA untouched until you die. However, this is probably not a good idea. Unless your spouse is the beneficiary, funds in your HSA become fully taxable income to the named beneficiary or your estate in the year of your death. So you should spend all of the money in your HSA before your die.
How much more will you have in retirement?
The answer will depend on how much you contribute and for how long you invest your money. For example, if you maximize annual contributions ($3,340 in 2017) and invest for a period of 30 years at 5% per year, you could end up with almost $230k more when you retire. That’s not counting the additional $1,000 catch-up contribution you can make once you’re 55 and older. For me, I’m using my HSA as a traditional IRA. I’ll just keep maximizing my contributions and investing my money until I stop working, and I’ll let it sit in the account until I’m 65. If I incur medical expenses along the way and am able to pay out of pocket, I’ll be sure to keep good records and receipts and enjoy my tax-free withdrawal at a later time. Either way, it’s nice to know that I’ll have some tax-free funds available for medical costs should the need arise.
Should you open an HSA?
Yes. In essence, an HSA is a triple tax advantaged account! You have the benefit of reducing your taxable income, your earnings grow tax free, and you can use the money on medical expenses without having to pay income taxes. If you’re eligible for a high deductible health plan, I would seriously consider signing up for one so you can have access to an HSA and some of its tax benefits. If used correctly, it can be a great way to boost your retirement savings.