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Funding HSAs for Retirement

HSAs are not generally thought of as retirement accounts, but they should be.

Most people don’t think about a Health Savings Account (HSA), like a savings account. HSAs are typically thought of as an account where you set aside money to spend on health care items during the current year. While, technically, that is true…that is not the ONLY purpose for a HSA. A HSA can be a great addition to an IRA or 401(k) plan, and, in some cases, it might actually be better to contribute to a HSA instead of the IRA.  (Note: As discussed in the last blog, to set up an HSA, you must be enrolled in a high-deductible insurance plan that meets the necessary qualifications.)

Could a HSA be better than an IRA?

A HSA account is basically a souped-up IRA. Most people are familiar with an IRA or 401(k)… basically, if you’re eligible, you get a tax deduction for the amount you contribute to the plan. The money grows tax-deferred, and then you pay taxes when you withdraw it in retirement.

The HSA is unique because of the additional benefit of tax-free withdrawals for qualified medical expenses. The HSA is the only type of account that has this double tax benefit; deductible contributions and some tax-free withdrawals. After age 65, if HSA funds are not needed for medical expenses or insurance premiums, they can be used the same as funds in your IRA or 401(k). You’ll pay taxes on any withdrawals that are not used for medical reasons, but after age 65, there is no penalty tax.  This makes HSAs a smart retirement savings option.

For most individuals, health insurance premiums and medical expenses of some kind are a certainty. Why not pay for them with tax-free dollars?

  • Prior to age 65 HSA funds cannot be used for health insurance premiums, but can be used to pay for qualified medical expenses (co-pays, deductibles, dental care, etc.).
  • After age 65 HSA funds can be used to pay for health insurance premiums (including Medicare Part B premiums & long-term care insurance premiums).

When looking at all your options and estimating expected health care costs after retirement, I think you will see a HSA can be a very effective way to save to meet these costs.

Are there downsides to funding an HSA instead of an IRA?

I listed some HSA/IRA differences below:

  • With a HSA, funds can be used at any age for qualified medical expenses and are tax-free when used for this reason.
  • For withdrawals that are not used for medical reasons:
    • HSA – 20% penalty tax applies (up to age 65)
    • IRA – 10% penalty tax (disappears at age 59½)
  • Must be enrolled in a qualified high deductible health plan to be eligible to contribute to an HSA.
  • HSA contribution limits are lower than than those for an IRA.
  • HSAs have no required minimum distributions – IRAs do.

Now, how HSAs & IRAs are similar:

  • Both offer tax-deductible contributions (if you are eligible).
  • Money grows tax-deferred.
  • Penalty taxes can apply to withdrawals that do not follow the rules.

As a final thought, the best retirement savings option is usually a combination of 401k, IRA and HSA investments. The bottom line is that everyone’s situation is different. You should weigh the pros and cons of each option to determine the best retirement saving strategy for you.