How to Use an HSA to Save for Retirement (and Reduce Your Taxes)

HSAs Provide Tax Savings That Can Help You Prepare for Retirement

Paying for the cost of health care. Peter Dazeley/Getty Images

How to determine if you are eligible to contribute to a Health Savings Account   

You must participate in a high-deductible health plan (HDHP) to be eligible to contribute to a Health Savings Account (HSA). In general, a health insurance policy must have had a deductible of at least $1,300 for individual coverage and $2,600 for family coverage in 2015.  Annual out-of-pocket expenses (deductibles, copayments, and other amounts, but not premiums) cannot exceed $6,450 for self-only coverage and $12,900 for family coverage.

Many bronze and silver plans purchased on the exchanges are also HSA eligible.

Reduce taxes now and build up savings to pay for health care now or later

Health savings accounts provide much-needed protection to help pay for current and future health-related expenses.  HSAs can also benefit you by lowering your income taxes. You can contribute up to $3,350 for individual coverage and up to $6,650 for family coverage for 2015. If you are age 55 or older, there is an additional $1,000 catch-up contribution until Medicare eligibility at 65.  If you and your spouse are both 55 or older and not enrolled in Medicare, you can both make a catch-up contribution. However, dual catch-up contributions should be made in each spouses’ respective HSA.

You can estimate potential tax savings from a contribution to a health savings account using this calculator or the TaxCaster from TurboTax.

You have until the tax filing deadline to contribute to your HSA if you didn’t already max out your contributions for the current tax year

The majority of HSA participants prefer the ease and convenience of payroll deductions.

Most people do not recognize the ability to make direct contributions to an HSA outside of work.  You can contribute directly to an HSA by simply writing a check or setting up automatic transfers from your bank account. You can even elect to use a different HSA bank.  Just remember when determining how much you can possibly add to your HSA to include contributions made by your employer during 2015 with your contributions for the 2015 tax year.

 

HSA contributions reduce your taxable income

Contributions to a health savings account are considered an “above the line” deduction.  As a result, this can help lower your adjusted gross income (AGI) and could even help you qualify for other deductions and credits that are dependent on your AGI. Another added benefit is you do not have to itemize deductions on a tax return to claim the HSA deduction. 

Health savings accounts essentially offer triple tax exemption. Your HSA contributions will reduce your taxable income today, grow tax-deferred, and can be withdrawn tax-free as long as you use it for health-related expenses. Growing concerns about rising health care costs make HSAs a valuable financial planning tool when saving for health care costs both now and during retirement.

Health Savings Accounts do not have a “use it or lose it” provision

This differs significantly from flexible spending accounts (FSAs) which only offer limited carryover of assets from one year to another. As a result, you can choose to leave HSA funds in your account as long as possible. Health savings accounts can also provide a variety of investment options to help your money grow.

The ability to let your HSA funds grow in a tax-deferred account provides a smart way to supplement your retirement savings.

  Unlike deductible IRA contributions, health savings accounts do not have income limitations. The primary requirement to contribute to an HSA is that you had to have been covered by a high-deductible health insurance plan with a health savings account attached to it during the 2015 tax year. However, it is also important to remember that HSA contributions must be made by the tax filing deadline (April 18. 2016) even if you are filing an extension.

If the HSA is not used for qualified medical expenses, then you will have to pay ordinary income taxes on the distribution plus a 20% penalty if taken prior to age 65.  One way to look at this is as if the HSA is a tax-deferred 401(k) with a 20% early withdrawal penalty until age 65 BUT with the added bonus of tax-free distributions if the money is used for qualified medical expenses.

  If you are lucky enough to have good health and low medical expenses, you simply have to wait until age 65 to avoid the early withdrawal penalty. 

Many financial planners recommend taking full advantage of HSA contributions after building your emergency fund and getting the match in your employer’s plan. The HSA is the only type of account that offers both pre-tax AND tax-free benefits.  It also provides funds to help pay for health care expenses which are usually a top concern once you reach retirement. In fact, it is often recommended to pay for health care costs out-of-pocket when possible to allow your HSA money continue growing tax-free for retirement.