How to Use Your HSA as a Retirement Plan
Whether you’re in the early stages of your working years or you’re nearing retirement, one of the biggest burdens that can dampen your golden years is healthcare expenses.
In fact, a recent study by Fidelity Investments found that the average couple at age 65 would need $315,000 saved to cover healthcare expenses. And that’s after taxes.
But one tool that can help you save for healthcare costs in retirement is a health savings account (HSA).
What is an HSA?
An HSA is a tax-advantaged savings vehicle that’s paired with a high-deductible health plan (HDHP) to help people pay for qualified healthcare costs. It’s most known for its triple-tax benefits.
- The money you contribute to an HSA is tax-deductible. So it can lower your taxable income and your tax bill for the year you contribute.
- Money in an HSA grows tax-free.
- Withdrawals for qualified healthcare expenses are tax-free.
In many ways, an HSA functions similarly to a traditional individual retirement account (IRA) or 401(k). But HSAs have major advantages. If you withdraw money from a traditional IRA or 401(k) to pay medical bills, the withdrawal would be taxed as ordinary income.
But if instead you tap into your HSA, you’d owe no federal taxes on the withdrawal as long as the expense is “qualified.” So what exactly are qualified medical expenses?
HSA qualified medical expenses may include the following:
- Health insurance deductibles.
- Dental and vision care.
- Prescription drugs and insulin.
- Medicare Part B and Part D prescription-drug premiums.
- Wheelchairs and walkers.
- Hearing aides.
- Ambulance services.
- Long-term care services for the chronically ill.
- Nursing home expenses.
- Nursing services at home.
But there’s more to it than that. Unlike with flexible savings accounts (FSA), HSA money rolls over into the next year. And unlike with IRAs, you’re not required to take required minimum distributions (RMDs) when you turn 72. So your money can keep growing until you need it.
Moreover, you keep your HSA if you change jobs.
Invest your HSA money
To make the most out of your HSA, you need to make it grow as much as possible. However, many employers offer HSAs that work like basic savings accounts collecting barely any interest. Today, the average savings account interest rate is just 0.13%.
Still, many employers offer access to a range of investment options. And if they don’t, you can always open an HSA online through an investment management company.
A self-directed HSA may give you access to a wide variety of investment options, including low-fee, exchange-traded funds (ETFs) and index funds.
These funds generally aim to mimic the return of market indices like the S&P 500, which contains stocks of some of the country’s biggest companies. The average return of the S&P 500 for the long term has been 10%.
In any case, you should invest your HSA dollars into a diversified portfolio based on your goals and risk tolerance. Several online tools can help you find an appropriate asset allocation or investment mix.
Think of your HSA as a retirement account
Even though an HSA was designed to help people pay for qualified healthcare expenses at any time, it can really come in handy when you retire.
As you age, your healthcare needs may become more complicated and so can the price tag. So try to cover current healthcare costs with out-of-pocket money and don’t touch your HSA until you retire. This gives you time to build a sizable nest egg to cover qualified healthcare costs tax-free.
And once you turn 65, you can withdraw money from an HSA penalty-free for anything. This money could supplement other retirement needs.
But keep this in mind: Money withdrawn from an HSA for any reason other than a qualified medical expense is taxable, even if it’s penalty-free and even after turning 65.
If you withdraw money from an HSA for a non-qualified expense and you’re under the age of 65, your withdrawal would face a 20% penalty in addition to regular income tax.
Max out your HSA
If you have an HSA, consider maxing it out if you can. For 2022, you can contribute up to $3,650 for individual coverage and $7,300 for family coverage. For 2023, you can contribute up to $3,850 for individual coverage and $7,750 for family coverage.
You can make an additional catch-up contribution of $1,000 if you’re at least 50 years old.
So let’s put this into perspective. Say you’re 40, on individual coverage, and you max out your HSA every year until you turn 65. Assuming a 10% annual return, your account would grow to $398,513.
But not everyone can max out their HSAs each year. So let’s take the same scenario but instead invest $1,200 a year ($100 a month). You’d end up with $131,018. Combined with other savings like tax-advantaged retirement accounts and Social Security benefits, this can help support a healthy and comfortable retirement.
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