Health savings accounts (HSAs) are commonly known as a way to cover healthcare costs with pre-tax dollars. What many people may not know is that HSAs are more than that, specifically when they are not used for medical expenses. Because most HSAs can be rolled over from year to year, those accounts can grow just like any investment account. And when HSA holders get closer to retirement, it’s possible they’ll find significant funds that no longer have many of the medical spending requirements attached. From all the tax advantages to earnings potential, there are a number of ways to use an HSA for retirement savings.
Use HSA tax advantages for retirement savings
While most consumers view HSAs as a tax-free way to offset high deductible costs, that’s only one of three tax advantages these plans have. The first advantage, which most people know, is that money used to fund an HSA actually reduces your taxable income in that given year. So if $7,000 is put toward an HSA, then the income tax paid is reduced by that number – $7,000.
The second tax advantage with an HSA is that funds invested through the plan can grow just like any other investment account. While the income earned from these investments is not tax-free, it is tax deferred. In other words, if an HSA grows and is taken out during retirement, the taxes paid on the investment income are based on the account holder’s income at the time the money is withdrawn.
The third tax advantage is that withdrawals from HSAs are tax free, even if there is investment income, as long as the withdrawals are used to pay medical expenses. These three things combine to be the triple tax advantage of HSAs.
Contribute the maximum to help retirement savings
Needless to say, with all the tax benefits already mentioned, anyone with an HSA should consider contributing the maximum amount to your HSA. As health insurance costs have continued to skyrocket, meeting deductibles gets harder and harder each year. By contributing the maximum, most consumers can cover the costs of high deductibles simply through their HSAs. However, if the money is not used for medical expenses in a given year, the roll-over opportunities from an HSA make even more sense because it can be used for retirement savings. Think of an HSA somewhat like a 401(k) plan. Each year, it’s wise to put as much as possible into a 401(k), and the same is true with an HSA. In fact, some say an HSA is even more valuable than a 401(k).
Invest HSA assets for retirement savings
Just like any other account designed to cover expenses during retirement, consumers should consider investing a portion of HSA assets in a way that aligns with other retirement plans. If you work with a financial advisor, you should review how to best use the HSA funds for investments, though only if there are funds left over after annual medical expenses. By understanding how to invest the money in an HSA, consumers can ensure their HSAs work with an overall retirement strategy.
HSA funds can be invested in various financial tools, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs). These investment options provide the opportunity for growth over the long term, allowing your HSA funds to help in the future. Being aware of these options and their potential returns is the best way to make informed investment decisions within your HSA.
Plan for nonmedical expenses in retirement
One significant advantage of HSAs is that after age 65, HSA funds can be used for non-medical expenses without penalties. While non-qualified withdrawals are subject to ordinary income tax, the absence of penalties after you turn 65 makes HSAs a versatile tool for supplementing retirement income. It's important to note that if you are below 65 and make non-medical withdrawals, a 20% penalty applies, along with the ordinary income tax.
Incorporating HSAs into retirement planning requires a thorough understanding of their unique advantages and considerations. By strategically leveraging HSA funds for health and retirement needs, individuals can bolster their financial security during their retirement years.
