The Health Insurance That’s Also a Retirement Plan

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Among the questions I’m asked most often is this one: Where do I save first? And for years, my answer has been the same: Sock away a few thousand in the bank or credit union for emergencies, then grab the 401(k) match, and, if you can max it out, then flesh out the emergency cushion before moving onto other tax advantaged opportunities like 529 college savings plans. Well, I’m changing my mind. Health Savings Accounts or HSAs belong as near to the top of the list as 401(k)s, and, in some cases, supercede them.

Here’s why.

Here’s How an HSA Works

First, a reminder of exactly what an HSA is and how it works. Health Savings Accounts are, well, savings/investment accounts that you are allowed to open if you purchase a qualifying high-deductible health insurance plan. In order to qualify in 2018, the deductible must be at least $1,350 for an individual, $2,700 for a family. Qualifying plans also can’t offer any benefits beyond preventative care before participants satisfy the deductible. And they must limit your annual out-of-pocket healthcare expenditure, not including premiums, to $6,650 for individuals, $13,300 for families. Once you open an HSA, individuals (and their employers, more on that in a second) can contribute up to $3,450 in pre-tax dollars for 2018, families $6,900, and individuals 55 and older an extra $1,000.

A Retirement Account in Healthcare Clothing 

As with 401(k)s, making a contribution reduces your adjusted gross income for tax purposes.

That’s good. More employers have also started to offer their workers carrots in order to get them to a) open their Health Savings Accounts and b) start to put money into them, explains health insurance expert Shelby George of Manning & Napier. That’s better—and here’s why. With 401(k)s, we talk about matching dollars.

Meaning: You have to kick in a little of your own money to get your employer to pony up with theirs. That’s not always the case with HSAs, where you can often get the incentive by just taking a health assessment, going for your annual (covered) physical, or opening the account. In other words, it may not cost you anything. When we refer to leaving free money on the table by not anteing up enough to capture the 401(k) match, we’re stretching things a bit; there is a cost to you to getting that money. In the case of HSA incentives, the money is often truly free.

It’s All in How You Use It

HSAs also have the ability to morph into retirement accounts later in life. Once you have an HSA and are making contributions into it, you can pay non-covered medical bills out of the account—essentially making those payments with pre-tax dollars and saving yourself a good 25 percent of every healthcare expense. But—and here’s the retirement wrinkle—if you can afford to pay your healthcare expenses with cash outside the account, you can invest the funds in your HSA. They can grow—just like 401(k) assets—tax-deferred. You can withdraw them, tax-free, to pay medical expenses at any time. But once you hit 65, you can withdraw them to pay for anything—and pay income taxes on the growth—just like you do with a 401(k).

In this way—particularly with all the talk in Washington about capping the number of tax-deductible dollars that can be contributed to a 401(k) to $2,400—the HSA becomes a valuable, supplemental retirement account. The one caveat here: If you intend on going this route, take a look at the investment options when you open your HSA. They’re often significantly more limited than the menu you’re used to for retirement.

And Then There’s the FSA…

Finally, while we’re talking about HSAs, a word about FSAs or Flexible Spending Accounts. Because they sound so much alike, many people confuse the two, notes Kim Buckey, Vice President of Client Services at DirectPath, a benefits consulting term. Unlike HSAs, where every dollar you contribute is yours to keep, FSAs are use-it-or-lose it. If you don’t spend the money by the deadline (often the end of the year), it’s gone.

But, while you’re making the decision to fund an HSA, you may want to put some money into an FSA, as well—specifically for dental and vision expenses. “If you have a high-deductible plan, you can’t use an FSA for medical expenses,” Buckey explains. On the flipside, “you can’t use an HSA for dental or vision unless it’s covered under your medical plan, which it typically isn’t.” So if you know how much you spend each year on contacts, or have big orthodontist bills on the horizon, socking some money into an employer-offered FSA can be a smart move for this year, as well.