The most recent research from the Employee Benefit Research Institute shows that few people are using HSAs to their full advantage. If they were, they would be maxing out their contributions each year, not withdrawing contributions to pay for current medical expenses and investing the balance in stocks and bonds, similar to how one invests retirement savings.
As noted in the introduction to this tutorial, HSAs have a triple tax advantage: Contributions aren’t taxed, withdrawals for qualified medical expenses aren’t taxed and investment growth isn’t taxed. That makes them more valuable than 401(k)s, Roth IRAs and other tax-advantaged accounts, which typically have only a double tax advantage.
You also don’t have to start taking distributions from an HSA at a particular age, as you do with a 401(k). Further, HSA contributions aren’t capped once you reach a certain income level, like Roth IRA contributions are, nor do you have to earn income to contribute in a given year.
A 5-Step Strategy for Your HSA
If you can afford to pay your current medical expenses out of pocket, you should strongly consider using an HSA to help you save for retirement. You can keep making contributions every year until you start claiming Medicare, and you can let the account balance grow as long as you like. Here are the basic steps involved in this strategy.
- Max out your HSA contribution each year. For 2018, those limits are $3,450 for self-only coverage, $6,900 for family coverage and an additional $1,000 catch-up contribution per spouse if you’re 55 or older, meaning a married couple can max out their contribution at $8,900. Any amount your employer kicks in also falls under that limit, so if your employer gives you and your spouse $2,000 and you’re both younger than 55, the most you would need to contribute from your own money is $4,900. Again, that’s pretax. (For related reading, see Who can make catch-up contributions to a Health Savings Account (HSA)?)
- Don’t spend your contributions now; plan to spend them in retirement. By leaving your account balance untouched until you retire, you’ll maximize its potential to grow through investment gains. In this respect, you want to treat it like you treat your other retirement accounts. (Learn more in Forget 401(k)s: Put Your Next Savings Dollar Here.)
- Pay cash out of pocket for your current medical expenses. For all the medical expenses you incur both before and after you meet your health insurance deductible, pay the bills out of your regular checking account. Yes, you’re missing out on the ability to use pre-tax dollars to ease the sting of your medical bills now, but the future payoff will be much greater than the current cost. If you have to break this rule because you don’t have the cash to meet your out-of-pocket expenses now, make sure you only use the money for qualified medical expenses so you don’t have to pay penalties of 20% plus regular income tax on your withdrawals.
- Invest your contributions for the long run. If you just let your contributions sit there, they will lose value over time because of inflation. You’ll also be missing out if you merely try to keep up with inflation. Instead, you want to think of your HSA as part of your overall retirement portfolio and invest it accordingly. If you’re currently invested in a mix of 80% stocks and 20% bonds, you should probably invest your HSA that way, too. You can choose your HSA administrator, so if your employer gives you a default option that doesn’t actually let you invest your money, go ahead and move your account. You might want to hold it at the same institution where you keep your other retirement assets.
- Use your account once you’re 65 or older. An added benefit to waiting until you’re at least 65 to spend your HSA balance is that the 20% penalty for withdrawing funds for purposes other than qualified medical expenses doesn’t apply. You can truly use the account as you would any other retirement account. That being said, you will have to pay income tax if you don’t use the funds for qualified medical expenses. If you’re retired and in a low tax bracket, the sting will be minimal, but you still want to avoid this tax bill if you can. So turn to your HSA first to pay your medical bills.
Used this way, a fully funded and wisely invested HSA can ease many of the concerns you might have about meeting expenses in retirement. You can use HSA funds to pay for Medicare and long-term care insurance premiums, hospital bills, prescription medications, doctor visits, in-home nursing care, long-term care services, nursing home fees and more. You can also use your HSA to reimburse yourself for a previous year’s medical expenses, as long as you had your HSA when you incurred those expenses, so save your receipts.
(For more detailed coverage of this topic, read How to Use Your HSA for Retirement.)
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