If you are familiar with healthcare benefits you have most likely heard of a Health Savings Account (HSA). Health Savings Accounts are an important component to not only your healthcare needs but also your retirement.
An HSA is much like a savings account, where it can be used to pay for medical expenses; however, financially savvy people are using these accounts to bridge the gap from early retirement till traditional retirement income kicks in.
Health Savings Accounts when used wisely, are the ultimate retirement tool. Think of them as a really smart way to save for retirement. Find out if an HSA Retirement option is right for you.
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What Is A Health Savings Account?
HSAs were created in 2003 for individuals covered by high-deductible health insurance plans. In fact, to qualify you must have a high deductible health plan. These savings accounts provide tax-relief and help to pay those out of pocket costs associated with high deductible plans.
With an HSA account, you can contribute up to $3,350 per year of pre-tax dollars for individuals and $6,750 for families. You can use the money contributed to pay for qualified health expenses at any time. Here’s the important part, if you never need it for health expenses or have a balance when you retire you can use it as retirement money.
Yes years later, like 10-15 years later that money can be withdrawn from your account and be used to pay for previous medical expenses– This is your golden nugget to early retirement. Let me explain…
How Do Health Savings Accounts Work?
If you are enrolled in a high deductible health insurance plan you can qualify for an HSA. These accounts are marketed as savings accounts for health care expenses yet financially savvy people use them as an IRA.– Think of them as retirement accounts in disguise.
Each year you decide how much you would like to contribute to your HSA account keeping in mind the maximums mandated by the government. Your HSA company will issue you a debit card that is linked to your account to pay for any eligible medical expenses, including copays, and coinsurance, plus other qualified medical expenses not covered by your plan.
Most of the population uses these accounts as a savings account to pay for medical expenses yet smart people disregard the medical aspect of the accounts and think of them as a special retirement account that you can contribute to if you have a high deductible insurance plan.
One of the benefits of these accounts is that your balance rolls over from year to year so you never have to worry about losing the money you have in your account. The money you contribute is not only pre-tax dollars but it grows tax-free and can be withdrawn tax free —3 tax advantages in 1 (or in other words completely tax free money!)
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Health Savings Account Eligibility
Anyone who is enrolled in a high deductible health plan is eligible. The IRS defines HDHP (high deductible health plan) in these terms and limits:
- The deductible must exceed $1,300 for individual
- The deductible must exceed $2,700 for
fam ily
Why Are HSAs So Important For Early Retirement?
One of the greatest benefits of HSA’s is they have three tax advantages and they provide much better tax breaks than a Traditional IRA, 401(k) or Roth IRA. In essence, it’s the ultimate combo of a Traditional and Roth IRA.
Tax-Free Contribution Accounts (Traditional IRA, 403b, 401k)
• Contributions are pre-taxed, meaning you don’t pay income tax on the money you contribute. If you make $100,000 a year and contribute $5,000 you only pay income taxes on the $95,000.
• The money is able to grow tax-free and you will only have to pay taxes when you withdraw.
Tax Free-Withdrawal Accounts (Roth IRA – Roth 401k)
These accounts are tax-free withdrawal. You pay taxes in the beginning, your money grows tax-free, then you withdraw tax-free.
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Health Savings Account
• Not only are you able to contribute tax-free money but you can withdraw tax-free. Potentially completely tax-free money!
Let’s say you make $50,000 per year, if you contribute $3,000 to your HSA you will be taxed as though you only make $47,000! Lowering your tax burden.
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How To Use HSA For Retirement
Remember earlier when I told you HSA’s don’t require you to take an eligible reimbursement at the time they occur. If you don’t pull money from your HSA it just rolls over and continues to grow. Since there is no hard and fast rule that says you have to use an HSA to pay for medical expenses you can take out the money whenever you want.
Let’s say you had an eligible medical expense that year for prescription costs and an ER co-pay totaling $500.
You have two options with your HSA
- First, you could withdraw the money now and use it to pay your bill. That money would be completely tax-free.
2. The other option and what I recommend is this. You pay your bill with cash on hand and save all your medical bills. (make digital copies of your receipts in case you physical copies disappear or wear out) By doing this your HSA will continue to grow tax-free.
Fast forward 10 years at the ripe old age of 45 and you want to retire. You can hand in those receipts 10 years later and withdraw from your HSA account completely tax-free. Just remember the covered medical expense must have happened after you started your HSA.
Now let’s say you don’t have enough qualified medical expenses to pull all your accrued savings out. At the age of 65, instead of 59.5 like an IRA, you can withdraw the money for any reason penalty free. You will have to pay tax for any withdrawal that’s not for qualified medical expenses, but that is no different than a Traditional IRA.
At the age of 65, an HSA is nearly identical to a Traditional IRA but with the added bonus of tax-free withdrawals for medical expenses which an IRA does not give you.
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Health Savings Account Setup
So like I said earlier you must be on a high deductible healthcare plan (HDHP) in order to qualify. This could be through an employer or on the open market. Be sure to check with your employer as some will match HSA contributions.
What qualifies for a high deductible plan?
- Individual deductible of $1,250
- Family deductible of $2,500
The contribution limit for 2018 is $3,450 for individuals and $6,900 for families.
If your employer doesn’t offer an HSA here are some options for you to look into to begin an HSA account.
In Review
• Don’t use your HSA to pay medical expenses. Treat it as a savings account and let it grow tax-free.
• Keep a very good record of your medical expenses. I recommend scanning or taking pictures of them so they aren’t lost or damaged-Remember without these records you won’t be able to access the money until 65.
• Shop around for a good HSA that allows index fund investing
• Here’s a list of qualified medical expenses for an HSA
• By using an HSA as an investment account you are funding a tax-free income source that you can use for early retirement. In addition, you are shielding yourself from income taxes during your working years.
If you aren’t using a spending tracker app it’s time. They are free and will make a big difference in how well you save. We use and recommend Personal Capital.
Thank you for explaining this in such an easy to understand way. A lot of articles I read about retirement funds have too much information and are so confusing but this makes it simple to understand the difference between the types of IRAs and the basics of an HSA.
My pleasure, I’m glad you learned something from it.