What if I told you that an account created to help address medical costs could also help secure your retirement?    It is called a Health Savings Account (HSA), and if you have access to one, do everything you can to take advantage.

What is a Health Savings Account?

HSAs exist alongside High Deductible Health Plans (HDHP); you can’t open an HSA without an HDHP. As the name suggests, an HDHP is a medical plan with higher deductibles and out-of-pocket costs than typical health plans. The design encourages participants to become more cost-conscious about health care, to educate themselves about associated expenses and less costly alternatives. To help save for and cover the out-of-pocket costs, Congress created the HSA. You can learn more here.

HSAs offer three tax advantages.

First, you make HSA contributions before deducting taxes from your paycheck.  You, your employer, or anyone else can contribute to your account.  But the IRS currently limits aggregate annual contributions to $3,600 for individuals and $7,200 for families.  If you are over 55, you can do an additional $1,000 per year.

Second, you can invest assets in an HSA, which grows tax-free inside the account.  Account-holders can invest funds that exceed a minimum threshold through a lineup similar to those available in a typical workplace retirement account.

Third, withdrawals or distributions from an HSA are tax-free when made for medical expenses.  The CARES Act of 2020 lengthened what was already a broad list of acceptable expenditures.  If you withdraw funds for non-qualified expenses before turning 65, you will owe taxes on the money plus a 20% penalty.

Other accounts offer one or two of these tax advantages, but no other combines all three.

You can carry over unused balances.

HSAs have no restriction about when to spend funds.  Any unspent funds will roll over indefinitely, and you may distribute them at any point in the future.  If you leave your job, your account goes with you.  Depending on your subsequent medical coverage, you may or may not be able to make additional contributions, but the existing contributions are yours to keep until you spend them.

So how does this help my retirement? 

We are all living longer, thereby increasing the odds of needing medical care at some point in our journey.  In addition, the U.S. is facing a retirement savings crisis due in large part to the ever-increasing costs of health care.   Consider that, according to the Employee Benefit Research Institute, a retired couple might need $325,000 in savings for a 90% chance of covering health care expenses in retirement.

Most account holders are choosing to spend their HSA funds rather than let them accumulate.  That isn’t the most tax-efficient use.    Better to contribute as much as you can to an HSA during your working years and take advantage of employer matches or contributions while minimizing withdrawals and letting the assets grow tax-free.  You can submit expenses years later, so long as you keep good records.  Every little bit you contribute will give you spending flexibility and greater peace of mind to manage retirement in the best way possible.

One drawback of an HSA is a limit on transferability.  You can pass your HSA to your spouse when you die, with the tax benefits intact.  However, for non-spouse beneficiaries, the account loses its HSA status, and the fair market value becomes taxable.  So you are encouraged to use the funds during your lifetime.

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