How an HSA Could Help Your Retirement


If you're worried about medical expenses during your retirement, you're not alone. According to the latest Retirement Confidence Survey from the Employee Benefit Research Institute, 45 percent of American workers don't feel confident that they will have enough money to take care of their medical expenses when they retire.

The good news is that you may be able to do something on top of socking away money into your 401(k) or IRA to plan ahead for your medical bills during retirement. Let's review what a health savings account (HSA) is and how it can help your retirement planning. (See also: How an HSA Saves You Money)

What is an HSA?

An HSA is a tax-advantaged medical savings account available only to people who are enrolled in high-deductible health plans (HDHPs). An HDHP is health insurance that has a lower monthly premium, but a high deductible. A deductible is the amount you must pay out of pocket for medical expenses before your health insurance kicks in.

An HSA helps you pay for qualified medical expenses such as doctors' visits and prescriptions that are not reimbursed by your HDHP. The beauty of an HSA is that you can contribute to it with pretax dollars by setting aside a portion of every paycheck, allowing you to reduce your taxable income. Depending on where you set up your HSA, you may be able to invest the money in mutual funds or other investments to help the funds grow faster. Whatever money you don't use during the year rolls over into the following year, meaning you could have a nice amount built up by the time you retire.

For your insurance plan to qualify as an HDHP — one that allows you to use an HSA — the HDHP must have a deductible of at least $1,300 for self-coverage or $2,600 for family coverage (as of May 2017). You can only use the money in the account for qualified medical expenses, and if you withdraw money from your HSA to use for other purposes before you reach age 65, you'll have to pay a 20 percent tax penalty.

To qualify for an employer-sponsored HSA, you can't be listed as a dependent on somebody else's tax return or enrolled in Medicare.

How an HSA can help your retirement

Here's how an HSA can give your nest egg a boost during your retirement years.

1. Avoid taxes on approved medical expenses

Without an HSA, if you took out $1,000 from your 401(k) to cover a medical bill during retirement, you'd pay applicable income taxes on the money you withdrew. And if you were to retire before age 59 ½, you would pay an additional 10 percent penalty tax for that 401(k) withdrawal. With an HSA, however, you never pay taxes when using funds for approved medical expenses.

2. Avoid the early withdrawal penalty on nonmedical distributions after age 65

The longer you hold an HSA, the more flexibility you'll gain to use your funds. Once you reach age 65, you can withdraw money from the account for nonmedical expenses without triggering that 20 percent tax penalty. Note that you'll still pay income tax on the distribution.

3. Gain access to more investment options

If your employer-sponsored retirement account gives you access to only a few investment options, an HSA may be a way to broaden your options for retirement investments. While some HSA providers limit investment options to an FDIC-insured savings account, many others offer the option to put money in a separate HSA investment account with several fund options, including mutual funds and low-cost index funds. (See also: Why Warren Buffett Says You Should Invest in Index Funds)

4. Increase annual contribution limits for your retirement savings

In 2017, a single tax filer can save up to $18,000 in a 401(k) and up to $5,500 in a Roth IRA (with catch-up contributions for those 50 and older of $6,000 and $1,000, respectively). With an HSA, that same tax filer can save up to an additional $3,400 to cover medical expenses during retirement, with a $1,000 per year catch-up contribution allowed for those aged 55 and over.

Take a look at HSAs

If you don't have a good employer-sponsored health plan, you could give your retirement plan a much-needed boost with an HSA, assuming you're eligible for one. The premiums on an HDHP can be higher than those of other health plans, so it's important to take a look at all of your alternatives. Since there are many considerations to keep track of, including taxes, medical expenses, and investment decisions, consider seeking the advice of a professional. (See also: Who to Hire: A Financial Planner or a Financial Adviser?)

The health insurance decisions you make now could help you have a more comfortable retirement.

[Editor's Note: An earlier version of this article noted that withdrawals after age 65 for nonmedical expenses are tax free. This is incorrect, and the article has been corrected to reflect that.]

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