Health Savings Accounts (HSAs) have been around since 2003 as a tax-preferred savings vehicle for participants in high-deductible health insurance plans. Despite their name, HSAs can serve as an excellent tool for retirement savings as well.
First, the basics. If your health insurance plan includes a deductible of at least $1,250 ($2,500 for a family), it is considered a High-Deductible Health Plan. Participants in a High-Deductible Health Plan are eligible to open an HSA and contribute up to $3,350 per year for an individual, or $6,750 per family per year. Like an Individual Retirement Account (IRA), there’s a “catch-up provision” that allows you to save an extra $1,000 per year if you’re age 55 or older.
Let’s be clear: HSAs are not retirement plans; but they are structured much like IRAs under IRS rules. Like an IRA, contributions to HSAs are pre-tax and grow tax-deferred. In addition, withdrawals are tax-free when used to cover qualified health care expenses, thus providing a triple tax-free benefit.
While the accounts were created to help people save for health care expenses, the reality is that they aren’t required to be used for this purpose. Unlike with Flexible Spending Accounts (FSAs), there is no “use it or lose it” provision. Funds in an HSA can roll over year after year. So even if you don’t take any withdrawals, you can continue to contribute to the HSA and enjoy the tax-deferred accumulation.
Once you reach the age of 65, any non-medical withdrawals from an HSA are taxed at your ordinary income rate, just like a traditional IRA. Younger investors face an extra 20% penalty. For a married couple maxing out their 401(k) and/or IRA contributions every year, the ability to save another $6,750 per year pre-tax is an appealing option.
Unfortunately, HSA holders often don’t take advantage of the investment component offered by some providers. According to the Employee Benefit Research Institute (EBRI), only 6.4% of HSA owners used the investment option in 2014. “A lot of people who have these accounts don’t know they can invest with them,” says Paul Fronstin, EBRI’s director of health research.
Retirement savings aside, a recent study by Fidelity suggests that health care costs for a 65-year-old couple living into their 80s will come to an estimated $260,000 during their lifetime. Given the choice between paying for these expenses with taxable/after-tax dollars from an IRA or savings account, or leveraging the triple tax-free benefit of an HSA, the benefits of including an HSA in the financial planning discussion becomes obvious.
As always, fees are a concern. It’s important to make sure you understand the underlying fees charged by your HSA provider. Some providers charge a monthly fee; others charge check-writing fees and/or transaction fees. It’s critical that you understand the nuances of your plan.
In the end, because you are able to contribute to an HSA even after you’ve maxed out your 401(k) and IRA, it does raise the cap on tax-deferred savings. Given the potential for massive health care expenditures in retirement, an HSA can serve as a way to increase retirement assets with the bonus of tax-free withdrawals for qualified medical expenses.
Contact Aurum Wealth Management Group to learn more about this and other strategies to meet your financial objectives.
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