As we head into the last quarter of the year, many of us are coming up on the time to re-enroll in our employer benefit programs. This leads nicely into a discussion of one of the best retirement accounts available. A secret retirement account, that wasn’t designed as for retirement savings in the first place. The Health Savings Account.
Where did the HSA come from?
The Health Savings Account (HSA) was created in 2003 as a way to help those with high deductible health insurance plans save for future healthcare costs. These plans were created for people that didn’t expect to need as much health insurance throughout the year. The health insurance company offers a less expensive plan, but the catch, is there is a higher deductible if you do get sick and need to get healthcare. The HSA is an account for someone with this type of plan to save money to use for future healthcare expenses in a tax-advantaged account.
Retirement accounts are designed to save you on taxes, but you do have to pay them at some point. With a traditional IRA or 401(k) you get to contribute pre-tax dollars, but the withdrawals are taxed as ordinary income in retirement. With a Roth IRA or 401(k) the reverse is true, you pay taxes now and can withdraw the funds tax-free in retirement. So why is the HSA one of the best retirement accounts available?
The beauty of the HSA is that you get to deposit pre-tax dollars into your account and as long as you have qualifying medical expenses, you can withdraw your money tax-free. This is the only account where you can both contribute and withdraw tax-free.
- 2018 Individual Contribution limit: $3,450
- 2018 Family Contribution limit: $6,900
- Contributions are made with pre-tax money, and can be made by you and your employer.
- Contribution limits apply to the money contributed by you and your employer.
- You can open an HSA if you have a high deductible plan at any time in the year.
- If you switch to a high deductible plan during the year, you get a prorated contribution limit. So, if you’re single and switched to a high deductible plan in September, and have it through the end of the year, your contribution limit would be $1,150 (4/12 x $3,450).
- Money can be withdrawn tax free when used for qualifying medical expenses.
- After the age of 59 ½ money can be withdrawn for any purpose and is taxed at ordinary income tax rates; essentially the HSA can function the same as a traditional IRA.
How to use an HSA as a retirement account
If the HSA was created for healthcare expenses how do you use it as a retirement account? The key lies in a little bit of planning ahead. With an HSA you are allowed to withdraw money from the account to pay for qualifying healthcare expenses. You can withdraw the money any time after the expense occurs and you don’t have to withdraw it in the same calendar year or within a period of time after the expense occurs.
You can allow the money in your HSA to grow by paying for healthcare expenses with after-tax dollars today, and reimbursing yourself from the HSA in the future.
By paying out of pocket, you allow your HSA contributions to continue to grow tax-free until you withdraw them. That could be another 30-40 years of tax free growth!
Let’s say I have a high deductible health plan for my family. That means I can contribute $6,900 into an HSA for the year. I estimate that my healthcare expenses that aren’t covered by insurance are around $500 per year. I can pay those costs with after-tax dollars and keep that $500 in my HSA to keep growing tax free. I just have to keep track of my healthcare expense receipts to withdraw the money at a later date.
If you happen to lead an exceptionally healthy life and don’t need to spend much on medical expenses, your HSA turns into a quasi-IRA after you turn 59 ½. You can withdraw your money tax-free for healthcare expenses as before, or you can withdraw it and pay income tax as you would with a traditional IRA.
Your HSA always belongs to you, not your employer. Even if you decide to switch away from a high deductible plan, you can still use your HSA for medical expenses and the money you contributed can continue to grow.
There are a few things to keep in mind when researching your HSA. More employers are starting to contribute to employee HSA’s so take that into consideration when deciding whether and how much to contribute. Most HSA’s require you have a certain balance in the account before you can allocate funds to investments. The amount varies, but is typically around $1,000. Some HSA providers don’t offer the option of investing in low-cost index or mutual funds, so do your research on the available investments before opening an account. The fees vary between HSA’s and some employers will cover the cost. If you leave an employer or they decide to switch to a new HSA provider be sure to check on the fees, it may make sense to open an account with another provider.
What do you think? Is the HSA is the best retirement account available?