Written by: Aaron Williams, CFP®
If you have access to a Health Savings Account (HSA), I have some great news: your HSA is, hands down, the king of all savings accounts, offering benefits that aren’t all available through other savings vehicles. Think triple tax benefits, complete portability, and investment options that can transform it from a basic healthcare fund into powerful fuel for your retirement income. If that sounds overly bold—or you simply can’t imagine that anything can top your trusty 401(k) plan—read on!
It’s pretty rare that a savings tool becomes available that has the power to make a new and dramatic impact on your retirement income, but the HSA is exactly that. Like the older and more commonly used Flexible Spending Account (FSA), an HSA is used to pay for qualified healthcare expenses in the current year. But unlike an FSA, your HSA is not a “use it or lose it” account and does not expire at the end of the plan year. That makes it an excellent vehicle for saving for future healthcare expenses on a tax-favored basis. And because healthcare expenses are very likely to rise as you age, it’s quite literally ‘money in the bank’ to cover higher healthcare costs during retirement.
Plus, while most retirement savings plans offer a double tax benefit, the HSA goes one step further to triple your tax benefits. With traditional vehicles, you either pay taxes up front and then grow your assets and benefit from tax-free withdrawals in retirement, or use pre-tax dollars, grow your assets tax-deferred, and then pay taxes when you withdraw the money. Using an HSA, you can contribute to your account with pre-tax dollars, and grow your assets tax-free, and make tax-free withdrawals (as long as they are used for qualified medical expenses). It’s the only completely tax-free savings vehicles I know of, which makes it a fantastic choice if you can get it.
Here are some other benefits that, in my mind, work together to make the HSA the king of all accounts:
- It offers flexible investment options. Many HSA plans offer investment options that allow you to invest your accumulated assets in select mutual funds and ETFs, or, in some cases, in a self-directed brokerage account (a benefit many 401(k)s don’t even have!). Once you’ve selected your investment option, you can often set your account to automatically invest funds each time you hit a pre-set balance. And if you need the assets to cover medical expenses right away, you can transfer a portion of your invested balance back to cash and have the money within days.
- You can use it for a large menu of qualified medical expenses. That includes many expenses you would expect to be covered, such as doctor’s visits, prescriptions, hospital services, and surgery, as well as some that may surprise you, such as acupuncture, hearing aids and batteries (which are not typically covered by health insurance), and even guide dogs. And while you cannot use your HSA to cover most insurance premiums, you can use it to pay premiums for Long Term Care (LTC), Medicare, COBRA, or health insurance while you are receiving unemployment benefits.
- It can serve as a tax-exempt emergency fund. You can withdraw funds to cover a non-medical emergency as long as you have unclaimed, qualified receipts from after you opened the HSA that add up to the amount you need. The catch: this approach requires some hardcore recordkeeping. To use past receipts, you must be able to show that the expense was paid entirely out of pocket; that it was not previously paid by another source (such as an FSA or secondary insurance); that is was not used as an itemized tax deduction in a previous year; and that it was used for a qualified medical expense. But considering that the fund is completely tax-free, the benefit can be well worth the headache!
- You don’t have to use the plan offered by your employer. While your HR department isn’t going to broadcast the news, you can almost always use a plan of your choice—not only the plan your employer has selected. My wife and I prefer an HSA plan we’ve picked ourselves, so my wife has opted to contribute to that plan instead of the one offered by her employer. Even her employer’s contributions go directly into the same account. (Our team is happy to help you find a plan that’s most suitable to your own needs.)
- It is completely portable. That means that if you leave your current employer, you can take the plan with you to your next position, and the next, allowing your balance to grow steadily over time. Ideally, you’ll have built up a sizable balance by the time you hit 65—the age cutoff for contributing to your account. You can then use the money to pay for allowable medical expenses in your later years. And if you choose to use the assets to pay for non-medical purposes, you can do so without penalties as long as you are 65 or older, making it similar to an IRA. The only catch: you’ll be taxed on the income at the time of your withdrawal.
- No Required Minimum Distributions (RMD). While traditional IRA and 401(k) accounts mandate that you take out a certain amount each year when you reach age 70½ (sometimes at very high tax rates if you are already receiving large pensions and Social Security benefits on top of the mandated withdrawals), HSA accounts do not have Required Minimum Distributions. This can help with estate planning for all of your accounts. A word of caution though: there are some tax differences if the account beneficiary is not your spouse. Talk to your advisor for guidance.
Of course, anything that sounds almost too good to be true is bound to have some caveats. If you use HSA funds for non-medical expenses prior to age 65, you will be taxed on the distributions and hit with a hefty 20% penalty. It’s also important to understand that because all HSAs are high-deductible plans, you’ll need to pay out-of-pocket for medical expenses until the deductible is met. That means you’ll need to have that cash on hand to cover your expenses until then. If you use prescription drugs, be aware that some plans require you to pay the pre-plan cost of your medications until your deductible is met. I have one client who calculated (and budgeted) her prescription costs based on the standard co-pay amount of $30/month. Once the high-deductible plan kicked in, her out-of-pocket cost jumped to $90/month for a single medication. The same can be true for doctors visit co-pays and other basic costs that are often negotiated down when using a lower-deductible, higher-cost plan.
Health Savings Accounts aren’t for everyone. If you anticipate high medical expenses, a healthcare plan with a lower deductible and out-of-pocket max may be most appropriate. If you don’t—and you want to take advantage of triple tax benefits while saving for your future—you really can’t do much better than an HSA account. With open enrollment just around the corner, now is the time to talk to your advisor to see if this king of savings accounts is right for you.
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