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Health savings accounts (HSAs) help people with high-deductible health insurance plans cover their out-of-pocket health care costs using tax-advantaged money. But you can also use an HSA to help fund your retirement.
Using an HSA for retirement allows you to enjoy unique tax benefits that combine the best features of a traditional IRA and a Roth IRA:
- Contributions are pretax. You can deduct contributions from your gross income and, if your employer contributes to your HSA, their contribution is also deductible.
- HSA funds grow tax-free. You don't pay taxes on interest, dividends or growth.
- Qualified distributions are also tax-free. As long as you use the funds for qualified health care expenses, they're tax-free.
These combined tax advantages are difficult to replicate anywhere else, making HSAs worth a look when you're saving for retirement. Just be sure to avoid the following mistakes if you're considering an HSA for retirement or health care:
1. Assuming an HSA Is Not for You
You may not have considered using an HSA if you didn't know about the tax advantages or even whether you're eligible. But HSAs apply to a wide group of people. To be eligible to contribute to an HSA, you must have a high-deductible health plan (HDHP). Here's how the IRS defines high deductibles:
|HDHP Deductible Requirements|
|Self-Only Coverage||Family Coverage|
|Minimum annual deductible||$1,400||$2,800|
|Maximum annual deductible and other out-of-pocket expenses||$7,000||$14,000|
Not all health care plans with high deductibles are HSA-compatible, so be sure to check before you select a plan. Deciding whether or not an HDHP works for you is a separate decision, also worthy of careful consideration. If it does work, you may be able to use the tax benefits of an HSA to maximize your retirement savings.
2. Not Paying Attention to Contribution Rules
Like most tax-advantaged accounts, HSAs have annual contribution limits, and if you contribute too much, you could be charged a 6% excise tax. Here are the contribution limits for 2022:
- Individuals may contribute up to $3,650 per year.
- Families may contribute up to $7,300 annually.
- People over 55 can contribute an additional $1,000 per year.
- Spouses over 55 can each contribute an extra $1,000 as long as they each have their own HSA account.
Once you reach 65 and start using Medicare, you can no longer contribute to your HSA. You can continue to use your HSA funds indefinitely, however, and there's no required minimum distribution: Funds can stay in your account for as long as you want.
3. Not Investing Your HSA Money
You may want to keep some of your HSA funds in cash to cover unexpected medical expenses in the near term. But once you've got a comfortable cushion, you might consider investing additional funds as you would other retirement funds. Remember, earnings in an HSA account are tax-free.
4. Using Up HSA Funds
The intended use for an HSA is to cover out-of-pocket medical expenses as they come up, not necessarily to squirrel money away for retirement. But if you'd like to use your HSA for retirement savings, you might consider covering some health care expenses with your regular savings or income instead. That way, you can dedicate more of your HSA funds to investing and post-retirement spending.
5. Using HSA Funds for Nonqualified Expenses
What can you pay for tax-free from an HSA account? For a full list, see IRS Publication 502, Medical and Dental Expenses. Here's a quick list of some qualified expenses:
- Premiums for Medicare Part B and Part D
- Out-of-pocket medical costs
- Long-term care insurance and services
- Dental treatment
- Eye exams
- Hearing aids
- Mental health services
While it's true that you'll need to spend HSA funds on qualified health care expenses to avoid paying taxes on distributions (and a 20% penalty if you're under 65), you can always withdraw your money and pay the taxes and penalty if you really need it. If you're 65 or older, the income taxes you pay on an unqualified distribution are essentially the same as what you pay if you put the money in a traditional IRA or 401(k) instead.
6. Not Accounting for Medical Expenses in Retirement
How much money will you need to cover medical costs after you retire? The answer may surprise you. According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple who was age 65 in 2021 could need $300,000 in after-tax savings to cover health care expenses in retirement.
Because it's hard to know what the future holds, you might consider reserving your HSA funds solely for medical care and not using the money for other expenses in retirement. Having a solid nest egg reserved for health care costs in retirement is never a bad move.
7. Tossing Your Receipts
Save your receipts for health care expenses you've paid for with non-HSA funds. You can reimburse yourself from your HSA for these documented expenses at any time and your distribution will be qualified—and therefore tax-free.
8. Not Naming a Beneficiary
Your spouse can inherit your HSA along with its tax benefits, but a non-spousal beneficiary will have to pay taxes on the HSA's fair market value when a transfer is made. Take this information into account when creating an estate plan or naming a beneficiary for your account.
The Bottom Line
Ultimately, using an HSA for retirement savings is just one tactic to consider as you plan for retirement. Though this strategy may not work for everyone, it is one unexpected way to maximize resources you're likely to need in retirement by saving money on taxes both now and later.