How would you like a triple-tax-free way to save for certain retirement expenses?
No, this isn’t the latest Nigerian email scam. Rather, it’s the very real advantage of a Health Savings Account (HSA), an investment vehicle available to those with qualifying high-deductible health insurance plans.
The pretax money you put in is meant to be used for that year’s unreimbursed health costs, but unspent funds can be rolled forward to grow tax-deferred and withdrawn tax-free at any later date to pay for health care.
After 65, you can also tap the account for nonmedical expenses without penalty; those withdrawals will be taxed as income just like a traditional IRA.
Considering that a 65-year-old couple leaving the workforce today can expect to spend $220,000 on health care, as Fidelity reports, it’s no wonder HSAs are gaining traction as a retirement savings tool. “They’re the best deal in town,” says Scottsdale, Ariz., financial planner Dana Anspach, author of Control Your Retirement Destiny.
Of course, the HSA works as a retirement account only if you can sock away more than you need for this year’s medical costs. Therein lies the challenge. Here’s how to ensure an HSA will offer you a healthier retirement.
Make sure you’ll benefit
Premiums on HSA-eligible health plans are less expensive than those of lower-deductible plans, but you could spend more overall depending on your health. That’s because of the deductible. In 2013, this must be at least $1,250 for individuals and $2,500 for families.
The HSA is meant to help you save for this and other out-of-pocket costs; in 2013, individuals can stash $3,250, families, $6,450. Those 55-plus can add another $1,000. Also, 72% of employers contribute — an average $920 for singles, $1,600 for families, Kaiser Family Foundation reports. Assuming you’re covered through work, your employer will pick a default custodian for the account.
To end up with a balance at retirement, you’d need to let some of the money in the HSA ride each year. The more you pay in, the better your odds of having leftover funds. Being healthy helps too. (Use the tool at wageworks.com/HSACalculator to compare an HDHP/HSA with other insurance plans, based on last year’s usage.) Medical needs are unpredictable, though, so also consider how you handle costs when they come up.
Jacksonville financial planner and MD Carolyn McClanahan says you’re more likely to have money to spare if you know how to work the health care system — e.g., comparing prices and asking for generic meds.
Fill the right buckets
Most HSA users tap their accounts for immediate health care costs, allowing what’s left to roll forward. To really grow the HSA, however, you could dedicate it to retirement by paying health costs with other savings. “This makes sense for those who have spare cash flow,” says Coral Gables, Fla., financial planner Joshua Mungavin.
Wherever you store the money, aim to set aside at least two times the deductible for current bills, says Anspach. Beyond that, how does an HSA fit into the hierarchy of retirement accounts? Though it has the best tax benefits, it isn’t as flexible as a 401(k) or IRA. Prior to 65, you pay a 20% penalty on nonqualified withdrawals, for example. So fund your 401(k) up to any match, then split your remaining money among a Roth IRA, 401(k), and HSA.
Invest for now and later
Keep money earmarked for today’s health care in cash. (Some custodians require you to maintain a cash balance anyway — typically $1,000 to $2,500 — before you can invest.) The rest of the HSA can be allocated as you would your other retirement dollars, says Mungavin.
Mutual fund choices tend to be limited though, notes Roy Ramthun, president of HSA Consulting Services. Some custodians offer less than 20.
No good ones in your employer’s offering? Roll it over to another custodian; compare options at HSASearch.com. You should be able to find investments you like.
HSA Bank, for example, offers a full brokerage via TD Ameritrade, while Health Savings Administrators lets you pick from 22 low-cost Vanguard funds. Examine account fees, too, as charges for banking services and account maintenance are common. You don’t want to avoid the drag of taxes only to have your balance pulled down by fees.