"Secret" Retirement Account
Don’t pass up your chance to get in on one of the best investment vehicles available anywhere: the Health Savings Account (HSA). What is an HSA and who can get one? An HSA is an account where pre-tax earnings can be deposited, up to $3500 per year for individuals and $7000 for families, and accumulate earnings tax-free. Amounts withdrawn from an HSA are tax-free when used to pay for qualifying medical expenses. You read that right, no taxes ever. With some thought and planning you can maximize this unique tax advantage and extend it from the present all the way through retirement.
In order to establish and make contributions to an HSA, you have to be enrolled in a High-Deductible Health Insurance Plan (HDHP). Premiums are generally much lower on HDHPs than regular health plans and the savings can be invested in the HSA. Of course, if you have medical expenses, you’ll probably use some of the savings in your HSA to pay co-pays and deductibles on your health plan. That’s why Congress created them. But, with good health, a little luck, and some shopping around, your uncovered medical expenses might be quite low.
Even if you do spend a significant portion of your HSA on medical expenses, it’s still much more advantageous than paying with after-tax dollars and then trying to claw back some savings by itemizing deductions on your tax return. First of all, itemizing only makes sense if deductions are greater than the new larger standard deduction and, even then, it only applies to medical expenses exceeding 10% of your adjusted gross income.
Don’t confuse an HSA with a Flexible Spending Account (FSA). Unused balances in an FSA are forfeited at the end of the year. HSA balances can be rolled over from one year to the next with no limit and used to pay for qualifying medical expenses in any subsequent year. It would not be unusual for a family that started young to accumulate a six-figure HSA as they approach retirement.
It gets even better. As you might imagine, if you use the HSA for anything other than a qualified medical expense, you must pay income tax plus a 20% penalty. But here’s the hidden gem:, if you’re over 65 the penalty is waived. In this sense it’s like an additional IRA that doesn’t count toward the IRA contribution limits. As you may be starting to see, an HSA can be an important component of a long-term retirement plan at any age.
When you start thinking about that, you may also note that there’s no requirement that medical expenses be paid first from an HSA. It may be advantageous to pay current medical expenses out of pocket with taxable income and instead roll over the HSA contributions to future years for medical expenses in retirement, which are generally higher. Carrying a separate account into retirement, on which you never have and never will have to pay taxes can be an excellent strategy. Depending upon your tax bracket, it may even be advantageous to contribute to an HSA before contributing to a 401 K, even if a small portion of the 401 K contributions is matched. Of course, you’ll have to run the numbers to see if this is true for your circumstances.
But here’s the big flaw: aren’t you a captive of very low interest rates in a HSA, maybe 1% or less? No. HSAs are portable and many different banks and brokerages offer HSAs with a
wide variety of investment options including stock funds.
The bottom line is that HSAs are near the top of the list for long-term investment choices, sometimes the very top. Consider maxing out your HSA prior to maxing out any other investment. Collect the information for your situation and do the math.