Many people don’t realize that a health savings account, or HSA, can be a powerful retirement savings vehicle. The reason is, from a tax perspective, the HSA is unique and offers a triple tax benefit:
• The money you contribute reduces your taxable income.
• Money within an HSA grows tax-deferred.
• Withdrawals are tax-free as long as the money is used for qualified health expenses.
Despite this generous tax treatment, there is no time limit on when funds must be used. An HSA doesn’t have a “use it or lose it” provision like the Flexible Spending Account or mandatory distributions at age 70.5 like an IRA. HSA funds can remain in the account for an extended period of time growing on a tax-deferred basis. This means that funds contributed now can grow tax-deferred for years or even decades, and then be distributed totally tax-free for future medical expenses in later life when you need it the most.
We urge clients who have an adequate emergency reserve to invest money into a Health Savings Account for long-term growth rather than as a tax advantaged tool for paying current medical expenses.
According to the Employee Benefit Research Institute, a person contributing to an HSA for 30 years could save up to $313,000 with a rate of return of 5 percent. If the rate of return was 7.5 percent, the savings would be $469,000 — if there were no withdrawals along the way. So only spending HSA funds as a last resort becomes a savvy way to save on taxes and invest for the future at the same time.
A health savings account has the additional advantages of portability. It stays with you when you change jobs or leave the market place. An HSA can even extend into death for the use of a surviving spouse — similar to retirement accounts. One potential drawback, however, is that the HSA will be closed and the monies taxable in the year you die for beneficiaries other than your spouse.
So if you are eligible for a high deductible health care plan, and if it makes sense for you, consider taking advantage of the unique tax treatment an HSA offers. Contributions to both a traditional retirement plan, such as a 401(k) or individual retirement account (IRA), reduce current taxable income but distributions are taxed along with subsequent investment returns.
A Roth 401(k) or Roth IRA has the benefit of tax-free withdrawals but contributions have no tax advantage. As a result, some individuals might find using an HSA as a savings vehicle even more advantageous than saving in a 401(k) plan (after the employer match is maximized) or other retirement savings plans.
Mark Keating, CFP, AEP, is a certified financial planner with Willow Creek Wealth Management (willowcreekwealth.com, 707-829-1146) in Sebastopol. It has served North Bay clients since 1984 and has been ranked one of the top 300 fee-only financial planning firms in the U.S. Wealth Matters is a monthly column by the firm’s partners.