Unfortunately, no one can escape old age. Eventually, time catches up with us all. And, as we get older, that usually translates to more medical bills. Current figures indicate that the average couple will need an estimated $280,000 to cover their medical expenses during retirement. However, this number will continue to go up since people are living longer. The good news is that a health savings account can help you plan ahead. Not only can it help pay for your healthcare costs, but there are also many tax and financial benefits when investing with your HSA.
What Is a Health Savings Account?
A health savings account, or HSA, is a tax-advantaged account available to people with a high-deductible healthcare plan. It was designed to help bridge gaps in health insurance to cover current or future medical expenses. You can use the funds to cover qualified medical expenses, which could be anything from prescription costs to medical equipment to deductibles. In addition to saving you money on insurance, an HSA can insulate you from the financial impact of unforeseen medical expenses.
Initially, your HSA is a cash account that functions like a savings account. Although, once your balance reaches the set threshold (usually $2,000), you can convert it into an investment account. Few people realize that your HSA can also be used as an investment vehicle to save for retirement.
Some financial advisors refer to health savings accounts as your “health IRA.” Like IRAs and 401(k)s, they offer several tax advantages. But similar to other investment accounts, there are limits on annual contributions. For the 2021 fiscal year, it is $3,600 for the individual, and $7,200 for families However, people over 55 can contribute an additional $1,000 each year.
What Are the Financial Benefits of an HSA?
An HSA offers investors several financial benefits. The most immediate one is the monthly savings on premiums. In exchange for the higher deductible, you receive a lower monthly premium. This is a great option for people who have few health concerns or rarely need to visit a doctor.
On the other hand, a health savings account can also be your emergency fund for medical expenses. If you have frequent medical bills, having a dedicated account can help you avoid using other savings and retirement accounts in an emergency. It bridges the gap from where insurance ends and out-of-pocket expenses begin.
And, your HSA account will continue to grow and earn interest as you make regular contributions. Since you have complete control over the account, you can dictate how you use it. If you change jobs, you retain your HSA with the option to leave it where it is or roll it over to your new employer’s plan. Furthermore, the balance rolls over from year to year, so you will still have access to all the funds in the account.
Most importantly, an HSA is a great way to supplement your retirement. As previously mentioned, you can also invest the money for long-term growth. Although you can withdraw funds at any time to pay for qualified healthcare costs, there is no minimum age or annual distribution requirements.
What Are the Tax Benefits of Investing with your HSA?
The tax benefits you receive when investing with your HSA make it an attractive investment vehicle.
1. You don’t pay income taxes on your contributions.
Like your Roth IRA, contributions to your HSA are tax-exempt. In turn, it also decreases your taxable income. This will save you even more money when it comes time to file your return.
2. Withdrawals for healthcare costs are also tax-free.
Another huge tax break is that any withdrawals to pay for qualified medical expenses are also tax-free. The combination of these two features makes it superior to both an IRA and a 401(k).
3. It grows tax-free.
Rounding out the trifecta of tax advantages, your HSA grows tax-free. Therefore, you won’t pay any taxes on your dividends, interest, or capital gains.
How Much Should You Keep in Your HSA?
Like all financial questions, there is no one-size-fits-all answer. The amount of cash you keep accessible in your HSA depends on what your goals and purposes are for holding the account.
At minimum, it’s a good idea to have enough money to cover the deductible in case you need it. If you have a persistent medical condition or plan to have major healthcare expenses in the coming year, (expensive prescriptions, pregnancy, surgery, other medical procedures, etc.) you should probably contribute more. However, don’t begin investing with your HSA too aggressively and neglect more pressing financial obligations.
The best way to determine how much to invest is to first decide if it will be a medical expense or an investment account. If it is going to be your emergency medical fund, calculate all your expenses from the previous year. For those who plan to invest, set your financial goals and limits as you would with your other accounts. Your HSA isn’t likely to become the highest-performing account in your portfolio. But, it’s a great way to invest extra cash and relieve the burden of medical expenses after retirement.
Investing Strategies with Your HSA
When you decide to invest with your HSA, you should adopt a similar investment strategy as with your other assets and risk profile. Along that same line of thought, you don’t want to withdraw from the account if it is primarily going to be used to invest.
Try to cover out-of-pocket expenses and don’t touch it until retirement when healthcare costs increase significantly. Unless you need to cover expensive medical costs now, this is the best way to take advantage of your HSA’s tax benefits. Since you have a dedicated account for healthcare costs, you can preserve your other retirement accounts. And, even if you need to use this money for non-medical purposes, you won’t pay the 20% after you reach age 65.
Before making any major investments, discuss your options with your financial planner. They can help you get a better idea of how an HSA can help you meet your short-term and long-term financial goals.