When saving for retirement, you’re probably aware of the benefits of using tax-preferred accounts such as 401(k)s and IRAs. You may not be aware of another type of tax-preferred account that may prove useful, not only during your working years but also in retirement: the health savings account (HSA).
HSA in a nutshell
An HSA is a tax-advantaged account that’s paired with a high-deductible health plan (HDHP). You can’t establish or contribute to an HSA unless you are enrolled in an HDHP. An HDHP provides “catastrophic” health coverage that pays benefits only after you’ve satisfied a high annual deductible. However, you can use funds from your HSA to pay for health expenses not covered by the HDHP. Contributions to an HSA are generally either tax deductible if you contribute them directly, or excluded from income if made by your employer. HSAs typically offer several savings and investment options. Withdrawals from the HSA for qualified medical expenses are free of federal income tax. However, money you take out of your HSA for nonqualified expenses is subject to ordinary income taxes plus a 20 percent penalty, unless an exception applies.
HSA as a Retirement Tool
During working years, if your health expenses are low, you may be able to build up a significant balance in your HSA. You can even let your money grow until retirement, when your health expenses are likely greater. An HSA may provide other benefits:
An HSA can be used to pay for unreimbursed medical costs on a tax-free basis, including Medicare premiums and long-term care insurance premiums, up to certain limits.
You can repay yourself from your HSA for qualified medical expenses you incurred in prior years, as long as the expense was incurred after you established your HSA, you weren’t reimbursed from another source and you didn’t claim the medical expense as an itemized deduction.
And once you reach age 65, withdrawals for nonqualified expenses won’t be subject to the 20 percent penalty. However, the withdrawal will be taxed as ordinary income, similar to a distribution from a 401(k) or traditional IRA.
At your death, if your surviving spouse is the designated beneficiary, it will be treated as your spouse’s HSA.