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Using Health Savings Accounts for Retirement

Most consumers that maintain a health savings account (HSA) fund it on an annual basis and use the account to pay for immediate healthcare costs as they arise. However, for tax-savvy, retirement-minded investors, HSAs can represent a tremendous long-term planning opportunity.

Health savings accounts were created as part of the Medicare Prescription Drug, Improvement, and Modernization Act which was signed into law in 2003. A consumer can contribute to an HSA plan if she is:

If a person meets the above criteria, for the 2016 tax year, she can open an HSA and contribute $3,350 for an individual or up to $6,750 for a family. Contributions to an HSA are tax deductible (similar to a traditional IRA). If the money is used for healthcare costs, the contributions and gains are withdrawn tax free (similar to a Roth IRA). The money can accumulate inside the HSA indefinitely and the money can be invested according to the consumer’s goals and risk tolerance; more information can be found at the IRS website detailing HSAs.

When it comes to using the HSA, most consumers treat it like a bank account. They deposit funds, take the tax deduction, remain in cash, and pull the money out as opportunities arise. However, consumers with excess emergency cash that can defer pulling money from the HSA to cover immediate medical costs should consider taking a longer-term approach and treat the HSA like a retirement account. (For related reading on investing, see: 5 Steps to Getting Started in Investing.)

Helping With Retirement

Many custodians allow HSA holders to invest in a broad range of stocks and bonds similar to more traditional types of investment accounts. If the funds aren’t used for healthcare costs by age 65, account holders can withdraw the funds without penalty, albeit subject to income tax—similar to an IRA. Dissimilarly to an IRA, there are no required minimum distributions at age 70.5. 

For better or worse, Americans are all going to have healthcare costs in retirement. It is for these healthcare costs where HSA dollars shine. They can be used to buy long term care insurance or pay for all of the things Medicare won’t cover. The numbers below provide a rough illustration comparing an HSA with a Roth IRA and a traditional IRA assuming a consumer is in the 28% marginal income bracket, contributes $6,750 to each account every year for 30 years, earns 6% returns, and invests any tax deductions back into a taxable account where she pays an effective tax rate of 20% on the gains annually. (The tax code is complicated and just because something is deductible for one person doesn’t mean it will be deductible for another with different types of income and assets. Speak with a tax advisor before making any decisions.) (For more on retirement planning, see: 4 Mistakes to Avoid With Your Retirement Plan.

 

IRA

Roth

HSA

Growth of Contributions

$407,276.15

$565,661.32

$565,661.32

Growth of Tax Savings

$127,165.34

 

$127,165.34

Total

$534,441.49

$565,661.32

$692,826.66

       

The numbers above are rough. For example, the difference between the Growth of Contributions for the HSA and IRA reflects the assumption that the consumer has withdrawn the money from the account at the end of year 30 and paid a 28% income tax on the lump sum. This isn’t perfect, but it gets the idea across. 

The HSA in this scenario, when deferred over a long period and then used to pay healthcare costs, is a huge six figure opportunity for maximizing dollars in retirement. (For more about investing, see: Where Do Investment Returns Come From?)