This is the only retirement account I would recommend to anyone
Let’s talk about retirement accounts. Whether you work for an employer or yourself, you likely have access to more than one tax-efficient account where you can save for retirement.
Some retirement accounts offer tax savings today, while others are designed to limit your future taxes. If you want both – tax-deductible contributions now and tax-free withdrawals later – you only have one option. It’s called the Health Savings Account, or HSA, and it’s the only retirement account I would recommend to anyone.
You can save in an HSA only if you have a high deductible health plan, or HDHP. The IRS sets HDHPs based on the plan’s deductible and refundable limits. The threshold values may change periodically, but they are as follows:
- In 2021 and 2022, HDHPs must have a minimum deductible of $ 1,400 for individual coverage or $ 2,800 for family coverage.
- In 2021, HDHPs must cap personal expenses at $ 7,000 for individuals and $ 14,000 for families. The 2022 maximums are $ 7,050 for individuals and $ 14,100 for families.
If your HDHP goes through your employer, you may be able to enroll in an HSA during your company’s annual open enrollment period. However, your employer can offer an HDHP but not an HSA. In this case, you can open an HSA with a financial company such as Fidelity.
Triple tax advantage
Here’s the coolest thing about the HSA: It’s the only retirement account that offers a triple tax advantage:
- HSA contributions are tax deductible in the current year, up to the IRS limit.
- HSA investment income is tax-deferred.
- All HSA withdrawals that pay medical expenses (at any age) are tax free. Medical expenses can include coinsurance, copayments, dental care, vision care, chiropractic visits, prescriptions, etc.
Other HSA benefits
HSAs have more to offer beyond compelling tax benefits, including:
- Free matching contributions. Some employers will match your HSA contributions. The match formula may be less generous than your 401 (k) match, but who cares? It’s still free money.
- Transferable funds. The money you put in your HSA is yours. If you quit your job, you take the funds with you. Note that you may have to forgo employer matching contributions if you are not fully vested.
- Investment possibilities. HSA funds can and should be invested. Depending on where you hold your HSA, you may have access to a menu of funds or the full range of exchange-traded securities.
- No rollover restriction. There is no obligation to use your HSA funds by the end of the year. You can carry over your balance indefinitely.
HSAs are powerful, but they’re not perfect. They have drawbacks that can cost you money or prevent you from saving as much as you want. Four notable drawbacks of HSAs are eligibility requirements, withdrawal penalties, low contribution limits, and potentially too much flexibility on withdrawals.
- Eligibility rules. You can’t contribute to an HSA if you don’t have HDHP. You are also not eligible for contributions if you are covered by Medicare, Medicaid, or a spouse’s health plan. This means that you must stop contributing to your HSA when you enroll in Medicare, usually at age 65. All funds accumulated in your account at that time belong to you and can remain invested.
- Penalties for withdrawal. Non-medical withdrawals from your HSA are still taxable. If you make a non-medical withdrawal before age 65, you will pay a penalty in addition to tax.
- Low contribution limits. In 2022, you can contribute up to $ 3,650 to an HSA if you have an individual HDHP. If you have a family HDHP, you can contribute up to $ 7,300. If you are 55 or older, you can add $ 1,000 in catch-up contributions to these limits. These aren’t huge numbers, even when you add in the catch-up contributions.
- Withdrawal flexibility. You can make tax-free withdrawals from your HSA at any age, as long as you are using the money for health care. On the one hand, this is an advantage. If you don’t have money available in your checking account for your contact lenses, for example, you can get the money back from your HSA.
This flexibility also adds complexity, especially if you are saving specifically for retirement. To build wealth in your HSA for health care expenses in retirement, you may need to forgo using your funds for the short term. You can also estimate your short-term medical expenses, keep that amount in cash, and invest the rest. Unfortunately, this plan can easily tip over if you have an unexpected illness or injury.
HSA for now and later
Your HSA can save you money right now with tax-deductible contributions and tax-free withdrawals for medical expenses. But this account really does work when you use it to save for retirement. Tax-deferred investment income can help you grow a good amount of money for future health care expenses.
Additionally, the ability to receive taxable non-medical HSA distributions after age 65 improves account versatility. If you are aging well and don’t need the funds exclusively for health care, you can use the money to support your 401 (k) balance – since 401 (k) distributions are also taxable.
This means that there is no risk of overfunding the HSA. Either you use tax-free distributions for medical expenses or you take taxable distributions for living expenses. It’s an account, but it can play two different roles in your retirement finances. This versatility could turn out to make the difference in your retirement preparation plan.