When it comes to preparing for retirement, most people think about building their 401(k), IRA, or other traditional retirement accounts. However, there’s a lesser-known savings tool that can be just as powerful—if not more so—when it comes to covering one of the biggest retirement expenses: healthcare. That tool is the Health Savings Account (HSA), and if you’re not using it to its full potential, you could be missing out on substantial tax savings and long-term growth opportunities.
In this post, we’ll break down what HSAs are, their tax benefits, and why they should be part of your retirement planning strategy.
What is an HSA?
An HSA is a savings account designed to help people with high-deductible health insurance plans (HDHPs) cover medical expenses. But it’s much more than just a short-term savings vehicle for healthcare. HSAs come with a triple tax advantage that makes them unique:
- Tax-Free Contributions: Money you contribute to an HSA is tax-deductible or, if done through payroll deductions, not subject to Social Security or Medicare taxes.
- Tax-Free Growth: Any investments within the HSA grow tax-free, allowing your savings to compound over time.
- Tax-Free Withdrawals: As long as you use the funds for qualified medical expenses, withdrawals are tax-free as well.
Under IRS rules, you can contribute to an HSA only if you’re enrolled in a high-deductible health plan. These plans typically have lower premiums but higher out-of-pocket expenses. HSAs help offset the cost of those higher deductibles and offer a long-term savings opportunity.
Why Are HSAs Important for Retirement?
When planning for retirement, healthcare is often one of the largest expenses retirees face. A typical retired couple may need over $300,000 to cover healthcare expenses during retirement. With medical costs continuing to rise faster than general inflation, it’s more important than ever to prepare for these expenses in advance.
That’s where the HSA shines. It allows you to save specifically for medical costs, tax-free, while also acting as a supplemental retirement account. If you don’t use the funds immediately, they remain in your account, grow over time, and can be used for medical expenses in retirement.
HSAs as a Supplemental Retirement Account
Most people think of their 401(k) or IRA as their primary retirement savings vehicle, but an HSA can function as an additional retirement account. If you’ve already maxed out your 401(k) or IRA contributions, an HSA offers another place to stash tax-advantaged savings.
Unlike a flexible spending account (FSA), HSA funds don’t expire at the end of the year. They roll over indefinitely, meaning your money can grow for decades. You also retain ownership of the HSA, even if you leave your job or switch health plans. That flexibility makes HSAs a powerful long-term savings tool.
For 2024, the contribution limits are:
- $4,150 for individuals
- $8,300 for families
- Individuals aged 55 or older can make an additional $1,000 catch-up contribution.
Employers often contribute to employee HSAs as well, with the average employer contribution in 2023 being around $726.
The Flexibility of Reimbursements
One often-overlooked benefit of HSAs is the flexibility in how you can use them. You don’t have to withdraw money from the account the same year you incur medical expenses. For instance, if you use after-tax dollars to pay for medical costs now, you can save those receipts and reimburse yourself tax-free from your HSA years or even decades later. This allows you to maximize the growth of your account while still getting the tax benefits. Imagine this: you pay for a $2,000 surgery today using after-tax dollars. You tuck that receipt away and let your HSA funds grow tax-free for 20 years. Later, when you’re ready to access your HSA in retirement, you can reimburse yourself the full $2,000, tax-free, whenever you choose. It’s like giving your future self a financial bonus!
HSAs in Retirement
Once you turn 65, you can still use your HSA funds for non-medical expenses without facing a penalty. However, you will have to pay taxes on those withdrawals, much like a traditional 401(k) or IRA. But the flexibility here is key—there’s no 20% penalty for using the funds for non-qualified expenses after age 65. And again, if you’re paying for medical expenses from years past those withdrawals are tax free. This makes HSAs even more versatile as you enter retirement.
Additionally, HSAs are not subject to required minimum distributions (RMDs), which means you’re not forced to take money out at a certain age. You can keep your funds in the account, allowing them to grow until you’re ready to use them.
Investing Your HSA Funds
Many HSA providers allow you to invest the funds in your account, much like a 401(k) or IRA. This can be a game-changer for long-term growth. Most providers require you to reach a certain balance before you can start investing, but once you do, you can choose from a variety of investment options.
If your employer’s HSA doesn’t offer the investment options or fee structure you’re looking for, you can shop around for an HSA provider that does. Just keep in mind that if you open an external HSA, you won’t benefit from automatic payroll deductions, and you’ll need to contribute using after-tax dollars. You’ll also have to reconcile those contributions on your tax return.
Big Picture
HSAs are an incredibly valuable tool for both short-term medical expenses and long-term retirement planning, but they should be viewed within the context of your entire financial plan. How much should you contribute? When should you start using the funds? These are important questions to consider.
If you’re unsure about how to incorporate an HSA into your retirement strategy, it might be time to consult a financial advisor. At The Hourly Advisor, we specialize in creating customized financial plans that align with your goals. Let’s work together to maximize your retirement savings and ensure you’re prepared for future healthcare costs.
Conclusion
HSAs are often misunderstood, but when used correctly, they can be a powerful tool for retirement savings, especially when it comes to covering healthcare costs. With their triple tax advantages and long-term growth potential, HSAs should be on your radar, especially if you’re enrolled in a high-deductible health plan.
If you’re ready to learn more about how an HSA can fit into your financial plan, schedule a free consultation at The Hourly Advisor. Together, we’ll help secure your financial future, one step at a time.