As we discussed in a recent blog post, proposed legislative changes could almost double the amount health savings account (HSA) owners are allowed to contribute annually. Financially-savvy individuals have been using their HSA as an option to supplement their retirement savings for years. An HSA has certain tax advantages that an IRA or 401(k) does not. In this post, we will discuss a few ways that an HSA can be used to create future savings.
With a 401(k) or IRA funds are usually taxed at the time they are withdrawn from the account (except in the case of Roth accounts, which are taxed first). This means that if an individual uses only a 401(k) or IRA to save for retirement, they will not have a fully tax-free option to cover medical expenses later in life. Also, they may have to rely on an employer-sponsored FSA or HRA (which come with other restrictions and risks – like not being owned by the individual) to get a tax break on out-of-pocket medical expenses before retirement.
An HSA is the only account that offers triple-tax advantages now and in the future. This means that funds are contributed tax-free, they grow tax-free and they can be used to pay for qualified medical expenses (you guessed it) tax-free.1 If an individual uses an HSA, instead of an IRA or 401(k), to save and spend for qualified medical expenses, they will have significantly increased buying power in retirement.
For example, a 65-year-old couple retiring today will need $404,253 for total lifetime healthcare costs.2 If this money is saved in an HSA, those dollars will be accessible for qualified medical expenses without paying any taxes. A traditional IRA or 401(k) would require $577,504 in savings (assuming a 30% total tax rate) to cover the same expenses.
Save now, cash-in later
In addition to increased buying power, there is no deadline to reimburse yourself from your HSA. Individuals can pay for qualified medical expenses out-of-pocket (instead of using their HSA) and save the records of those expenses to build up a tax-free distribution amount over time.3 While this option isn’t feasible for every person, it is a smart way to benefit from compounding interest and perhaps plan for mid- to long-term savings goals like a vacation, a car or a down payment for a home.
After age 65, HSAs can be used to cover any expense without a tax penalty. If the expenses are not qualified (and there are no past medical expenses to reimburse), you just pay normal income tax on that amount. In this way, your HSA works like an IRA or 401(k), but retains its tax-free feature for qualified medical expenses.
The saving power of an HSA will be enhanced if currently-proposed legislation makes its way into law. That said, the features and advantages described above are already a part of how HSAs work today. Individuals and companies who are serious about their retirement and health strategies will not hesitate to take advantage of these benefits and will use HSAs as a key part of their health retirement roadmap.
1 HSAs are never taxed at a federal income tax level when used appropriately for qualified medical expenses. Also, most states recognize HSA funds as tax-free with very few exceptions. Please consult a tax advisor regarding your state’s specific rules.
2 HealthView Services: 2017 Retirement Health Care Costs Data Report©
3 Qualified medical expenses must be incurred after the establishment date of the HSA to be eligible for reimbursement.
HealthEquity, Inc., does not provide legal, tax, financial, or medical advice. Always consult a professional when making life changing decisions.