Health Savings Accounts (HSAs), coupled with a high deductible health plan, were designed to help make healthcare more affordable and give people more freedom in their personal healthcare decisions. Another advantage of the account is the ability to use it in retirement. Due to generous tax advantages, friendly contribution options, and investment opportunities, more people are looking at their HSAs as part of a long term strategy. Here’s what you need to know about your HSA and retirement.
HSA and Retirement
Before discussing account usage in retirement, let’s first review some HSA basics and how you can build up your balance.
Tax Advantages Help HSA Money Grow
HSAs offer a convenient and effective financial way for people to cover the high costs of healthcare deductibles and other out-of-pocket expenses. However, because HSAs offer several tax advantages, they can also supplement other retirement accounts.
HSAs offer some distinct tax advantages that benefit growing accounts:
- Contributions are tax free. All funds deposited into an HSA account are pre-tax, which lowers the participant’s total taxable income.
- Healthcare expenses are tax free. As long as they are used to pay medical expenses, HSA withdrawals are not taxed.
- Account growth is tax free. Interest earned on the balance and investment gains are not taxed.
- Tax deferred. Any unused money in an HSA account grows tax-free, with all taxes deferred until the participant withdraws the money at age 65 or older. The money is then taxed (when used for a non-qualified expense), usually at a lower rate.
Similar to retirement accounts, HSAs have annual maximum contribution limits. In 2020, the limits are $3,550 for individuals and $7,100 for families. If a participant can’t afford to contribute the maximum amount, spouses, parents, and friends can make contributions. Employers who offer HSA plans are also allowed to contribute.
All money in the account at the end of the year carries over to the following year; there is no “use it or lose it” provision like with some Flexible Spending Accounts. The account balance can continue to grow tax-free until the participant withdraws it.
Another boon for those approaching retirement age are ‘catch-up’ contributions. At age 55, HSA owners can begin making additional contributions of up to $1,000 over the annual limit to their accounts. This raises the total annual contribution limit to $3,550 for individuals and $8,100 for families.
Investing Your HSA Funds
While an HSA acts like a basic savings account, paying minimal interest, they also allow you to invest the money in mutual funds for greater returns. Some HSA providers require a minimum account balance (many as low as $1,000) in order to begin investing. Once you save enough to meet the threshold, investing your HSA balance offers a way to grow your retirement savings quickly.
Using Your HSA in Retirement
Ultimately, an HSA can be more flexible than an IRA or 401k retirement account. Those other retirement accounts are taxed on all withdrawals, no matter the reason.
After age 65, you can continue to use your HSA tax and penalty-free for qualified healthcare expenses. Some estimates put healthcare costs during retirement at $325,000 on average. Saving and using your HSA rather than dipping into a 401k or IRA is a smart strategy.
If you need, you can also withdraw HSA funds like an 401k or IRA for other retirement expenses. After age 65, any money withdrawn from the account for non-medical expenses gets taxed at the participant’s current tax rate; there is no penalty. However, if you’re under age 65, an HSA distribution for a non-qualified expenses (healthcare or otherwise) will incur a 20 percent penalty on top of being taxed.
For healthy people with minimal healthcare costs and who invest the unused money wisely, HSAs offer a safe and tax-effective tool for creating a larger retirement nest egg. Your HSA and retirement go hand-in-hand, no matter how you use it.
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