As you’re planning for retirement, there are several tools you can take advantage of to help you save — a workplace 401(k), for example, or an IRA. Plans like these allow you to invest your money for the future, racking up serious savings along the way.
There’s one other tool that can help you build a stronger nest egg, yet the vast majority of workers don’t fully understand it: the health savings account (HSA).
While 57% of workers say they have a good understanding of how an HSA works, according to a recent survey from Bank of America, only 11% can name four of the HSA’s most distinguishable features.
An HSA can be a lifesaver in retirement, especially if you face high healthcare costs (which the average retiree will, even with Medicare coverage). So it’s more important than ever to understand this vital retirement tool and how it affects your savings.
What is an HSA, exactly?
You may know that an HSA is an account that helps you save money for medical expenses, but it’s more than that. It’s essentially a mini retirement fund just for healthcare costs, and it has some serious advantages.
There are four traits of the HSA, though, that the majority of workers don’t understand. The most commonly misunderstood feature, according to Bank of America’s report, is that it offers a “triple tax advantage.” When you invest in an HSA, your contributions are tax-deductible up front. Then your money grows tax-free while it’s in your account; and finally, you can also avoid paying taxes on your withdrawals as long as the cash goes toward qualifying medical expenses. When you’re saving specifically for healthcare expenditures, the tax savings of an HSA can’t be beat.
The second most misunderstood HSA attribute is that your funds can be invested. An HSA isn’t simply a savings account just for healthcare expenses. As with a 401(k) or IRA, you can invest the money in your HSA in the stock market to maximize its grow over time, and see much higher returns than if you were to simply stash your cash in a savings account.
Another one of the HSA’s commonly misunderstood traits is that the money doesn’t expire. Unlike a flexible spending account, money in an HSA doesn’t have to be used within a certain amount of time. You can invest it and let it grow for decades if you’d like, not withdrawing it until you need it.
Finally, the fourth distinguishable feature is that in order to be eligible for an HSA, you need to be enrolled in a high-deductible healthcare plan. That means your current health insurance plan must have a deductible of at least $1,350 (for individuals) or $2,700 (for families). If you are eligible for an HSA, there’s also a limit to how much you can contribute each year. For individuals, that limit is $3,500, and for families, it’s $7,000. Those who are 55 or older can also take advantage of catch-up contributions, meaning you’re allowed to save an additional $1,000 per year.
Knowing exactly what an HSA is and how it works is only one step of the equation. The next step is to learn how to make the most of it.
Maximizing your HSA
If you’re eligible to open an HSA, it can be a powerful tool in your retirement planning toolbox. Healthcare costs are skyrocketing, and even with Medicare coverage, the average retiree spends approximately $4,300 per year on out-of-pocket medical expenses, according to a study from the Center for Retirement Research at Boston College.
Because HSAs have the triple tax advantage, your money can go further toward healthcare costs when you invest it in one of these accounts versus a 401(k) or IRA. Also, keep in mind that the money in your HSA doesn’t only have to be used for healthcare expenses. Putting it toward medical costs is the only way to avoid paying taxes on your withdrawals, but if you need the money for other reasons, you’ll just need to pay income taxes on it like you would for 401(k) or traditional IRA withdrawals.
When saving for retirement, it’s important to balance saving in your retirement fund and your HSA. That can be tough, though, if you don’t have much cash to spare. If you have access to a 401(k) with matching contributions from your employer, make it your top priority to earn as much “free money” as you can. Next, try to balance your retirement account and HSA contributions based on the rates of return you’re earning on each of them. If your 401(k) contributions are earning a 7% annual return, for example, while the money in your HSA is generating a 5% annual return, it might be a good idea to prioritize your 401(k) while still ensuring you have some cash stored in your HSA.
Also, because HSAs have lower contribution limits than 401(k)s and IRAs — 401(k)s have a limit of $19,000 per year in 2019, while IRAs are limited to $6,000 per year — if you max out your HSA, you can simply stash the rest of your savings in your retirement account.
An HSA is a powerful way to save for one of the largest (and most unpredictable) expenses you’ll face in retirement. But to save as much as possible, you’ll need to know how an HSA works as well as how to maximize it. By making the most of your HSA, you can save more for retirement and prepare for any other hurdles life may throw your way.
