Using an HSA to Accelerate Your Retirement Savings

Most people who are familiar with HSAs know that it can help you pay for eligible healthcare costs using pretax money. What fewer people know is that HSAs are also set up in a way that makes them excellent vehicles for saving and investing money for retirement.

In this article, we’ll outline a few ways you can use an HSA to accelerate your retirement savings.

What is an HSA?

An HSA, or health savings account, is a tax-advantaged savings account that can help you save and invest money to pay for qualified healthcare expenses now and in the future.

Many people think of HSAs as short-term savings vehicles that are only useful for paying immediate healthcare costs. This belief, however, ignores the most important aspects of health savings accounts—the “savings” element.

HSAs have several advantages that make them one of the most powerful tools to help you save for retirement under current U.S. tax laws.

Benefits of using an HSA to save for retirement

Maximizing your income during retirement is important because expenses in retirement continue to grow. A recent study showed that the average couple spends roughly $315,000 for healthcare throughout their retirement. Help your other retirement income stretch further by saving money in your HSA.

There is a popular misconception that you can’t have an HSA once you’re enrolled on Medicare. You absolutely can! While you can’t contribute to the account anymore once you’re on Medicare, you can still use the funds you have already saved. Just as before retirement, you can use the money completely tax-free to pay for any qualified healthcare expenses in retirement. Also, once you reach age 65 you can withdraw money from the account penalty-free, meaning you’ll only pay income taxes on your distributions no matter what you use the money for. This means that withdrawals from your HSA for non-healthcare expenses are comparable to similar withdrawals from a traditional IRA or 401(k).

Let’s look at some of the reasons more and more Americans are recognizing the value of an HSA in helping them reach their retirement goals.

HSAs are triple tax-advantaged

HSAs are unique because they allow you to contribute money on a tax-free basis, earn money on your savings tax-free and withdraw money tax-free (as long as you use the money to reimburse qualified expenses).

Specifically:

You can make contributions to the account pretax or deduct the amount you contribute on a post-tax basis from your taxable income. The amount you save will depend on your tax bracket but can be significant.

You won’t have to pay taxes on any interest, dividends, investments or other sources of growth your funds experience while in the account. This means you can safely invest and grow your funds without having to pay any taxes.

Any distributions you take from the account are tax-free, provided you spend the money on a qualified expense. Note, however, that distributions for non-qualified expenses will cause you to have to pay income tax and a penalty imposed by the IRS.

Taken together, these three facts can result in up to tens of thousands of dollars in tax savings over the life of the account (assuming you max out your contributions every year).

Generous contribution limits

The IRS determines the contribution limits that apply and adjusts them each year. You can see the current contribution limits here. Additionally, the IRS allows catch-up contributions for account holders age 55 and older to give an extra boost to your account as you approach retirement.

While the contribution limits are lower than IRAs or 401(k)s, they’re still significant enough to build a hefty nest egg, provided you start early and save consistently.

Don’t miss opportunities to make additional contributions to your account. Receive a promotion and/or raise at work? Consider increasing your per pay period deduction. Receive an annual bonus? Consider a one-time contribution. Looking for a way to save on taxes? Consider a prior year contribution so you can still contribute up to the maximum in the new year.

HSAs are 100% vested immediately

Unlike some retirement savings accounts, money contributed to your HSA is 100% yours from day one, even if you change health insurance plans, change jobs or stop working. The account and the money in the account are yours forever, and you can decide when and how to use the funds.

Also, anyone can contribute to your HSA—you, a family member, a friend, your employer or anyone else. No matter where the money came from, it is still 100% yours.

Your HSA may provide earning potential

Depending on your HSA administrator, you may have options to help your account balance grow without having to add more money.

Many HSA administrators pay interest on their cash deposits. Depending on the interest rate schedule, the balance you maintain in your account and the length of time you hold the account, the interest can really add up to give your account balance a boost.

Additionally, your administrator may offer the opportunity to invest a portion of the funds once you reach a certain savings threshold. As mentioned earlier, your money can go in tax-free and grow tax-free over time, allowing you to accelerate your savings in an environment perfect for long-term growth. This can be an effective way to build out a nest egg to help pay for your retirement.

This potential for growth over time mirrors the growth potential of other tax-advantaged accounts, such as IRAs and 401(k)s, with the added benefit of not paying taxes on qualified healthcare expenses.

You have the freedom to decide how to use your funds

There are no rules or restrictions on when you must use your HSA funds, meaning you can save your money in this tax-advantaged account for years leading up to retirement. There is no use-it-or-lose it rule like there is for other benefit accounts such as HRAs or FSAs. Also, there are no mandatory distributions like some other retirement accounts such as IRAs and 401(k)s.

If you would like to use your HSA for retirement income, you have a couple of options:

Save your funds and use them in retirement to pay for healthcare expenses you incur in retirement including Medicare premiums, out-of-pocket expenses, etc.

Track your expenses over the time you were enrolled in the HSA and wait to reimburse yourself until retirement. You can reimburse the expenses at any time you want—little by little or all at once. The choice is yours!

Eligible expense list grows on Medicare

Once you enroll on Medicare, you can still use your HSA for all the same healthcare expenses as you could before, but now, you can also use HSA funds tax-free for additional expenses you couldn’t before!

Common healthcare expenses in retirement include:

• Medical Procedures
• Hospital Bills
• Prescription Drugs
• Medicare Part B Premiums
• Medicare Part D Premiums
• Out-of-Pocket Expenses
• Home Healthcare
• Long-Term Care Expenses

The IRS penalty ends for non-qualified expenses at age 65.

Normally, withdrawing funds from an HSA for a non-healthcare expense will require you to pay income tax plus a 20% tax penalty. However, withdrawals after the age of 65 don’t carry this penalty. This means that you can use your HSA funds for anything in retirement and you’ll only have to pay income tax on the funds.

Using the funds for eligible healthcare expenses is still best, since you will avoid both income tax and the penalty, no matter your age.

The funds can pass to your spouse tax-free

When you open a new HSA, you’ll be able to name a beneficiary (or beneficiaries) who’ll receive the funds in the event you pass before depleting the account.

For an HSA, there are three general outcomes depending on who (or what) you name as your beneficiary:

If you name your spouse as your beneficiary, the money from your account will be received tax-free. Your spouse may be required to open their own HSA to receive the money: however, your HSA administrator will be able to assist with the account opening.

If you name someone other than your spouse as the beneficiary, your beneficiary will have to pay taxes on the full amount in the year in which you pass. Note, however, that if your beneficiary is also an inheritor of your estate, they may use the funds to pay down any qualified healthcare expenses owed by your estate for up to one year after your passing (which may result in your beneficiary paying less in taxes).

If you name your estate as the beneficiary of your account, the IRS will count the fair market value of the account against your final income tax return. This means that your estate will pay taxes on the full account’s amount before distributing the remainder to your heirs.

Note that this is an extremely simplified summary of the rules surrounding estate planning with HSAs. We highly recommend that you speak with an estate planning attorney about your HSA if you have any questions about changing your beneficiary or want to minimize the tax impact.

Make your HSA part of your broader retirement planning strategy

As you can see from the benefits described above, HSAs are a powerful tool and are one of the most advantageous vehicles currently available for saving money for retirement.

Navigating the various rules surrounding HSAs—and finding the best way to combine them with your other retirement plans—can be complicated. For this reason, it’s strongly recommended that you speak with an experienced financial professional before making any changes to your retirement planning strategy.

If you have any questions about HSAs, or if you’re considering opening a new account, please call our Participant Services at 800-270-7719, schedule an appointment online or visit us at any of our Associated Bank locations.

Opening a new HSA doesn’t have to be difficult, and our team is here to help guide you toward HSA and retirement planning strategies that work for you.