Whether you’re in the early stages of your working years or nearing retirement, one of the biggest burdens that can hold back your golden years is healthcare costs.
In fact, a recent study by Fidelity Investments found that the average couple at age 65 would need $315,000 in savings to cover health care expenses. And that’s after tax.
But one tool that can help you save for healthcare costs in retirement is a Health Savings Account (HSA).
What is an HSA?
An HSA is a tax-advantaged savings vehicle that is combined with a high-deductible health plan (HDHP) to help people pay for qualified health care costs. It is best known for its triple tax advantages.
- The money you contribute to an HSA is tax deductible. This may therefore reduce your taxable income and your tax bill for the year of your contribution.
- Money in an HSA grows tax-free.
- Withdrawals for eligible healthcare expenses are tax exempt.
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In many ways, an HSA works similar to a traditional Individual Retirement Account (IRA) or 401(k). But HSAs have major advantages. If you withdraw money from a traditional IRA or 401(k) to pay for medical expenses, the withdrawal will be taxed as ordinary income.
But if you instead dip into your HSA, you’ll owe no federal tax on the withdrawal as long as the expense is “qualified.” So what exactly are eligible medical expenses?
HSA-eligible medical expenses may include the following:
- Health insurance deductibles.
- Dental and vision care.
- Prescription drugs and insulin.
- Medicare Part B and Part D prescription drug premiums.
- Wheelchairs and walkers.
- Hearing aids.
- Ambulance services.
- Long-term care services for the chronically ill.
- Retirement home fees.
- Home nursing services.
But there is more than that. Unlike Flexible Savings Accounts (FSAs), HSA money rolls over to the next year. And unlike IRAs, you don’t have to take required minimum distributions (RMDs) when you turn 72. So your money can keep growing until you need it.
Plus, you keep your HSA if you change jobs.
Invest your HSA money
To get the most out of your HSA, you need to grow it as much as possible. However, many employers offer HSAs that function like basic savings accounts earning virtually no interest. Today, the average interest rate for savings accounts is only 0.13%.
Yet many employers offer access to a range of investment options. And if they don’t, you can always open an HSA online through an investment management company.
A self-directed HSA can give you access to a wide variety of investment options, including exchange-traded funds (ETFs) and index funds at low fees.
These funds generally seek to mimic the performance of equity indices such as the S&P500, which contains shares of some of the largest companies in the country. The average long-term S&P 500 return was 10%.
Either way, you should invest your HSA dollars in a diversified portfolio based on your goals and risk tolerance. Several online tools can help you find an appropriate asset allocation or investment mix.
Think of your HSA as a retirement account
Although an HSA was designed to help people pay for eligible health care expenses at any time, it can really come in handy when you retire.
As you get older, your health care needs can become more complicated, and so can the price tag. So try to cover current healthcare costs with money out of your own pocket and don’t touch your HSA until you retire. This gives you time to build up a significant nest egg to cover tax-free qualified health care costs.
And once you reach 65, you can withdraw money from an HSA without penalty for anything. This money could supplement other retirement needs.
But keep this in mind: Money withdrawn from an HSA for any reason other than a qualifying medical expense is taxable, even if it is without penalty and even after you reach age 65.
If you withdraw money from an HSA for an ineligible expense and you are under age 65, your withdrawal would be subject to a 20% penalty in addition to regular income tax.
Maximize your HSA
If you have an HSA, consider maxing it out if you can. For 2022, you can contribute up to $3,650 for single coverage and $7,300 for family coverage. For 2023, you can contribute up to $3,850 for single coverage and $7,750 for family coverage.
You can make an additional $1,000 catch-up contribution if you are at least 50 years old.
So let’s put that into perspective. Let’s say you’re 40, have individual coverage, and max out your HSA every year until you turn 65. Assuming a 10% annual return, your account would grow to $398,513.
But not everyone can maximize their HSAs every year. So let’s take the same scenario but instead invest $1,200 per year ($100 per month). You would end up with $131,018. Combined with other savings like tax-advantaged retirement accounts and Social Security benefits, this can help support a healthy and comfortable retirement.
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