What Is an HSA?
A health savings account is a tax-advantaged savings account specifically intended for paying health care costs. Contributing to and using the account to pay for qualified medical expenses gives you a significant discount on your health care costs, and it’s a powerful tool for retirement saving. But the penalty for using the money for other than medical purposes is steep: You’ll pay income tax on the funds withdrawn, plus a 20% penalty. This changes when you reach age 65, however. You’ll still enjoy tax-free use of your HSA funds for qualified medical expenses, but you won’t pay the 20% penalty if you decide to access your money for non-medical uses. You must still pay income tax, however.
Do You Qualify for an HSA?
Not everybody qualifies for an HSA. The main rule is that you must be covered by a high-deductible health plan (HDHP). These plans require that you pay a significant portion of your health care costs upfront before your insurance kicks in. The plan must require that you pay at least the first $1,500 ($3,000 for family plans) and a maximum of $7,500 ($15,000 for families) for calendar year 2023 to qualify for an HSA.
Why Max Out Your HSA?
Some financial planners advise maxing out your HSA before contributing to an IRA because the tax benefits are so good. You get a tax deduction when you contribute funds, and you can roll over your funds from one year to the next. You don’t pay any taxes on the money upon withdrawal as long as you use the money to pay qualified medical expenses or, if you’re 65 or older, qualified health insurance premiums. You get just one or the other with an IRA. You get tax advantages when you contribute or when you withdraw, but not both. You get the tax benefits on both sides with an HSA.
There Are Contribution Limits
You can contribute a maximum of $3,850 or $7,750 for a family (the same limits that qualify for a tax deduction) as of 2023. Like other retirement accounts, these limits can adjust from year to year based on inflation rates. You can redirect contributions to an IRA, a 401(k), or another retirement account when you reach the maximum. Just like other retirement accounts, you’re allowed another $1,000 in catch-up contributions once you reach age 55.
Penalties for Unqualified Withdrawals
Your HSA funds must be used for qualified medical expenses. You’ll pay ordinary income taxes on the withdrawal plus that 20% penalty if you use the money for anything else and you’re under age 65. You could pay nearly 50% or more in taxes and penalties if you don’t use the money for its intended purpose. But you can use your HSA funds for things other than medical expenses after you reach age 65. In that case, ou’ll pay only ordinary income tax on those withdrawals.
Understand How Your HSA Funds Are Invested
Do some investigating before using your HSA as an investment vehicle. First ask about the financial firm that will hold the HSA funds for you if your employer offers you the HDHP with a health savings account. You won’t get much benefit from maxing it out if it’s nothing more than a basic savings account because the money isn’t being invested and earning better returns. Many account custodians will allow you to invest the funds into something more aggressive than a traditional savings account. The HSA becomes a vehicle for wealth building if your account comes with investment options.
Don’t Forget About It
Your HSA is your account to take with you if you leave your current employer, just like a 401(k). You can contribute to your HSA as long as you remain enrolled in an HDHP. Don’t forget about your account. Collect all the information about it from your human resources department.
Some Simple Math Shows the HSA’s Power
Let’s say that the maximum contribution never went up, and you contributed the maximum for an individual each year ($3,850) for 20 years and you earned a 4% rate of return. We’ll use a very conservative return rate because you’ll have some years where you’ll have to withdraw funds for medical expenses. Using these numbers, you would have a balance of nearly $124,000 that is completely tax free if it’s used on qualified medical expenses. Your medical expenses will become a larger part of your monthly budget as you age. Having this much money set aside for expenses that could also include long-term care later in life frees up your other retirement funds for other spending. Don’t view your health savings account as something to zero out before the end of each year. This is a valuable tool in your retirement savings arsenal.
