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  • Writer's pictureStephen Griffin

Take Advantage of Health Savings Accounts for Retirement Savings

A health savings account (HSA) is a specialized savings account to help save and pay for medical expenses for someone who has a high-deductible health plan, but with some thoughtful planning, an HSA can also be used to save for retirement with unique tax benefits.

Health Savings Account (HSA)

An HSA is a savings account to help people who have a high-deductible health plan. To qualify for an HSA, you must have a high-deductible health plan (HDHP) and no other health insurance. HSAs are designed to help save and pay for out-of-pocket medical expenses, but HSAs can also be an option for funding the retirement years.

Benefit: The Triple Tax Advantages of an HSA

The benefits of HSAs that are often underutilized are the potential triple tax advantages:

  1. Tax deductions allowable on the contributions

  2. Tax-free withdrawals when funds are used for qualified medical expenses

  3. Tax-deferred growth

Using one to save for retirement medical expenses is a better strategy than using retirement accounts.

1. Tax Deductions Allowable on the Contributions

Contributions to an HSA can be made with pre-tax payroll deductions, or with after-tax deposits from your own assets.

If you contribute to your HSA with after-tax dollars, these contributions are tax-deductible, even if you don’t itemize.

2021 Contribution Limits

  • $3,600 (self-only coverage) including employer contributions

  • $7,200 (family coverage) including employer contributions

  • $1,000 for catch-up contributions for those 55 and older *

Any contributions made by your employer to your HSA are not included in your taxable income.

2022 Contribution Limits

*If you are 55 or older, you can deposit catch-up contributions of $1,000 per year. If both you and your spouse have your own HSA accounts and you are both 55 and older, you can both contribute the extra catch-up in your own HSAs.

Remember, to qualify for an HSA, your health insurance must be a High Deductible Health Plan (HDHP); therefore, your HSA contributions are tax-deductible only until you enroll in Medicare.

2. Tax-Free Withdrawals When Funds Are Used for Qualified Medical Expenses

When you have qualified medical expenses to be paid, those do not have to be paid directly by the HSA. You can be reimbursed by the HSA after you pay the expenses. As always, keep your receipts and proof of payment in case you later face an IRS audit or in case the HSA custodian has questions about any withdrawals.

If you must use the HSA funds, be sure to spend them on qualified medical expenses. Withdrawals for qualified medical expenses are not taxable. These distributions are not taxable.

If you use the HSA funds on non-qualifying expenses before age 65, the tax penalty is steep at 20%, plus you will also owe income tax on those withdrawal dollars.

Use of HSA funds after age 65 is not subject to a penalty, no matter what the funds are used for. If the withdrawn dollars are used on non-qualifying expenses, you will owe income tax on those dollars, with no penalty.

3. Tax-Deferred Growth: Don't Spend Your Contributions

However, one strategy to optimize the triple tax advantage is to max out the allowed contributions while you are working, as much as possible, and pay current medical expenses out-of-pocket. This allows the HSA funds to compound with time and to be available for use during retirement.

Unlike a 401(k) or an IRA, you are not required to use the funds on any timeline. The balance can be carried over from year to year.

Also, many HSAs can be investment accounts rather than the typical savings account. Any interest, dividends or capital gains earned are income tax-free.

Pro Tip: Use HSA Funds for Tax-Free Cash in Retirement

With an HSA you are not required to reimburse yourself in the same year you incur a medical expense. The only limitation is that you can’t use an HSA balance to reimburse yourself for medical expenses you incurred before you established the account.

It is advisable to keep your receipts for all healthcare expenses you pay out of pocket after you’ve opened the HSA. Then in later years, if you have money in your HSA that want to spend on non-qualifying expenses, you can use your HSA funds to reimburse yourself for the expenses in previous years, tax-free. This allows you to use the cash in that account without increasing your tax bill for the year.

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