The Hidden Bonus That an HSA Can Provide for Retirement

The Hidden Bonus That an HSA Can Provide for Retirement

When you're signing up for health insurance, the sheer number of acronyms you come across (think HMO, PPO, HDHP) is enough to make you go cross-eyed.

But one of them could unlock a way for you to cover both your present health care costs and your future financial needs: the HSA, short for Health Savings Account. There are restrictions on who can open an HSA, and not every person is a great candidate for one. But if you do qualify, an HSA lets you save pre-tax dollars for health care expenses and you could use it to invest for retirement, similar to the way you invest in a 401(k) or IRA. Here’s what to know about this type of account.

How to Qualify for an HSA

To open an HSA, you have to be enrolled in a High Deductible Health Plan (HDHP). With an HDHP you typically pay lower monthly premiums than with other types of health plans, but your deductible (the amount you have to pay out of pocket until your insurance kicks in) is higher.

You should double check with your company to see which of the health plans they offer is the high-deductible option, because there are rules surrounding what qualifies as an HDHP. But one key, naturally, is the deductible amount. For 2018, the minimum deductible your health plan must have in order to qualify as an HDHP is $1,350 for individuals, and $2,700 for a family. If you have an HDHP, then you can save up to $3,450 per year into your HSA as an individual, or $6,900 for a family, according to the IRS’s 2018 allowances (those 55 and older can put in an extra $1,000). That pre-tax money can help pay for doctor’s visits, prescriptions and other health care costs.

How HSAs Are Different From FSAs

Although they sound similar, there's a key difference between an HSA and an FSA, or Flexible Spending Account. An FSA is also a special account that lets you save pre-tax money for medical costs, but whatever FSA money you don't spend at the end of the year, you forfeit. Some FSA administrators allow a $500 rollover to the next year or a 2½ month grace period to use up the money, but they aren’t obligated to. An HSA, meanwhile, isn't a use-it-or-lose-it account. Whatever money you put into your HSA is yours to keep, even if you change jobs or insurance plans. Plus, an HSA can also be an investment account, while an FSA is not.

HSA Tax Advantages

As with a 401(k), many HSAs allow you to invest some or all of the money you deposit in things like stocks and mutual funds. You can contribute to your HSA via payroll deductions that are tax deductible, and your employer may offer a matching contribution. But there's one big difference.

“[The HSA can do] pretty much everything a 401(k) or IRA does, and on top of that, any withdrawals for medical care are tax-free,” says Adam Leive, assistant professor of public policy and economics at the University of Virginia.

Prior to age 65, you can only withdraw money from an HSA to pay for qualified medical costs, or you’ll have to pay taxes on that money plus an IRS penalty. But starting at 65, you can withdraw money from your HSA for any reason. Medical withdrawals remain tax-free, while non-medical withdrawals are taxed as ordinary income. With a traditional 401(k) or IRA, any withdrawal after age 59½ is taxed as ordinary income. So when it comes to retirement, you can think of an HSA as getting all the benefits of a 401(k), plus tax-free health care savings for when your medical costs may be the highest.

Is an HDHP and HSA Right for You?

Whether to go with an HDHP really depends on whether you tend to have high medical costs.

“It doesn't make sense for everybody," says Katherine Hempstead, senior advisor at the Robert Wood Johnson Foundation. "Say you have rheumatoid arthritis or ongoing expenses, it may not make sense to go with a high deductible plan.” In addition, the tax benefits of an HSA aren’t as helpful if you earn a low income, as you won’t be paying that much in taxes in the first place.

But if you’re pretty healthy and make a decent living, you might be better off in the long run going with an HDHP and HSA, because any funds that you don’t use up each year for medical costs can continue to compound for the future. And as long as you’re enrolled in an HDHP, you could, in theory, max out your HSA contributions each year and leave the money in there to grow. (Once you no longer have an HDHP though, you can’t add more money to your HSA.)

In other words, having an HSA is like giving yourself extra money to grow for retirement on top of what you’re already contributing to a 401(k) or IRA, with the added plus of not paying taxes on any money you use for health care — a bonus that your future self may thank you for.

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