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estate planning for healthcare professionals

How To Properly Use Your HSA to Turbo-Charge Your Retirement Savings

Money saved in an HSA can help pay for out-of-pocket expenses.  But when used correctly, they  can also  be a significant part of your retirement savings. The possible tax advantages of an HSA can help you get the most bang for your buck not just for medical expenses today but also for saving for retirement.

What Is An HSA?

A health savings account (HSA) is a tax-advantaged account that can be used to cover qualified medical expenses. HSAs are designed to work together with an HSA-eligible high-deductible health plan (HDHP) offered by a employer. Through this employer benefit, you can typically opt into contributing money from each paycheck into a HSA. These contributions live in an account that can be used to pay for qualified medical expenses, like going to the doctor or buying prescriptions.  Employers can also contribute to your HSA as part of the benefit.

When used for qualified medical expenses, the money from an HSA is triple tax-advantaged. This means that each year you conribute to one, you can deduct that dollar amount from your taxable income. When you invest the money in an IRA, those investments grow tax-deferred, meaning you don't owe any capital gains taxes on that growth. Then on the back end, if you withdraw the money for qualified medical expenses, those withdrawals are completely tax free.  There is no other type of account that you can invest in that is like this. This is even better than a Roth IRA.

Starting at age 65, there is no penalty if you use HSA money for nonmedical expenses. You will have to pay income tax though, similar to pre-tax withdrawals from your 401(k). There is also no "use it or lose it" rule as there is in health flexible spending accounts (FSAs). Funds remain in your account year to year, and any unused funds may be used to pay for future qualified medical expenses.

How To Avoid Common HSA Mistakes And Maximize Their Benefits

The tax advantages of an HSA can help you get the most value out of your earned dollars as a tool for both health expenses and retirement. But you have to use them the right way. 

  • Mistake 1: Leaving your HSA funds in cash: Many people make contributions to their HSA, but forget to actually invest that money. So it doesn't really grow. That eliminates one of the biggest benefits of HSAs which is tax-free growth. Some employers may require that you keep a minimum balance in cash, $1,000 for example, but anything above and beyond that should be invested in the stock market. HSA plans will provide a variety of investment choices that will provde you exposure to the market and give your money the opportunity to grow over the long run. 
  • Mistake 2: Withdrawing from your HSA while you are still working: If you are simply withdrawing each year the same amount you contribute, nothing is left over to compound in the stock market. This again eliminates the benefit of tax-free growth that the HSA provides. What you should do instead, is have a separate high yield savings account designated specifically for paying out of pocket medical costs each year while you are working. You would replenish this as needed each year while at the same time making contributions to your HSA, which you would not be withdrawing from each year. 

This strategy could potentially lead to you retiring with a 6-figure nest egg in your HSA that you can then withdraw from tax free.  Some people may think they won't ever be able to spend that much in retirement on out of pocket medical expenses. But one of the nice things about an HSA is that in addition to normal out of pocket medical expenses such as co-insurance and co-pays, it can also be used to pay for medicare premiums, dental and vision expenses, and long-term care insurance premiums. 

If you are having to withdraw from your tax-deffered 401ks or IRAs to help cover these expenses, that will be considered taxaable income. This in turn could lead to you paying higher medicare premiums due to income-related adjustments (IRMAA).  

How do I know if I'm eligible for an HSA?

You're eligible to open and contribute to an HSA if:

  • You're covered by an HSA-eligible health plan on the first of the month
  • You're not covered by an ineligible health plan
  • You're not enrolled in Medicare (be aware of the 6-month look back rule)
  • You cannot be claimed as a dependent on someone else's tax return

What is an HSA-eligible health plan?

For 2022, the IRS defines HSA-eligible plans as high-deductible health plans (HDHPs) with a deductible of at least $1,400 for an individual and $2,800 for families. These health plans must also have an annual out-of-pocket maximum spending amount of no more than $7,050 for an individual and $14,100 for families.

High-deductible health plans could be compelling to those with minimal health expenses. Typically with a high-deductible plan your insurance premium is lower. You could look at it as instead of paying the insurer every month, you are paying yourself by contributing money to your HSA.