Forget 401(k)s, IRAs and everything you think you know about retirement accounts. The best place to stash your savings isn't a retirement account at all -- it's your health savings account (HSA). If you don't have one of these, or you don't even know what they are, you definitely want to read this.
Below, I'll explain what an HSA is, who qualifies for them, and how you can leverage one to jump-start your retirement savings.
What is a health savings account?
A health savings account (HSA) is a special type of savings account designed for medical expenses. Money you put into an HSA reduces your taxable income for the year, just like contributions to a traditional IRA or 401(k), so you can use it to keep savings away from Uncle Sam. You can withdraw HSA funds at any time to cover certain medical expenses, and unlike other retirement accounts, you won't owe penalties or taxes.
You may use the account to cover most medical costs, including vision and dental care. But you can't use it for elective procedures, like plastic surgery and cosmetic dentistry -- not if you want the tax break, at least. HSA funds spent on these procedures or non-medical expenses incur taxes, plus a 20% penalty if you're under 65.
Who can open a health savings account?
Anyone with a high-deductible health insurance plan may open an HSA. That's one with a deductible of $1,400 or more for an individual or $2,800 or more for a family in 2020. Some employers offer HSAs as an employee benefit, but if yours does not, you can open an HSA with most banks on your own, as long as you have a qualifying insurance plan.
If you later lose your qualifying health insurance plan, you may still use your existing HSA funds, though you may not contribute any more unless you get a new qualifying plan.
How much can you contribute to a health savings account?
Individuals may contribute up to $3,550 to an HSA in 2020 and families may contribute up to $7,100. Adults 55 and older may add another $1,000 to the above contribution limits, bringing their total to $4,550 for an individual plan and $8,100 for a family plan in 2020.
Why are health savings accounts a good place for my retirement savings?
HSA contributions give you a tax break today, as I explained above. If you've already maxed out your 401(k) or traditional IRA for the year, stashing money in an HSA can help you shave even more off of your tax bill. It may even drop you into a lower tax bracket.
The government never taxes HSA funds spent on medical expenses, so it's a great place to keep money you expect to spend on healthcare in retirement, including the cost of your Medicare or other health insurance premiums and deductibles. You could use a regular retirement account for this, but then you'd owe taxes on these withdrawals, unless they come from a Roth account.
Once you turn 65, the 20% penalty on non-medical withdrawals goes away. At this point, your HSA becomes similar to a traditional IRA. But while the government forces you to take annual withdrawals, known as required minimum distributions (RMDs), from your traditional IRA when you turn 72, that's not the case with HSAs. You can leave your money in your account as long as you'd like, only withdrawing funds as you need them.
Some HSAs enable you to invest your funds, just as you would with a traditional retirement account. You should definitely do this if it's an option for you, because it will help your money grow much more quickly than it would if you just left it in a traditional savings account.
If you have an HSA through your employer, you may also be able to set up regular deferrals from your paychecks like you can with a 401(k). Some companies also match a portion of their employees' HSA contributions.
The HSA's biggest drawback as a retirement account is its low contribution limits compared to other workplace retirement plans. But you can get around this by pairing yours with another type of retirement account, like a 401(k) or IRA. Start with your HSA first, unless your company offers a 401(k) with a match. Then, contribute to your 401(k) first and switch to your HSA once you've gotten your full match. If you max out your HSA, you can switch back to a 401(k) or IRA.
Opening an HSA isn't any more difficult than opening a regular bank account, so set aside a few minutes to look into it. Just make sure you have a qualifying health insurance plan first, and choose a provider that enables you to invest your funds. Then start contributing. When you're reaping the rewards of its triple tax advantage in retirement, you'll be glad you did.
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