It may seem counter-intuitive, but spending your Health Savings Account (HSA) contributions on medical expenses now could be a huge mistake. While medical expenses are a necessity, it could actually save you a lot of money to use your own funds to pay for healthcare costs, especially while you are young.
But before we discuss how to best utilize your HSA for retirement, let’s look at how HSA tax incentives work.
Getting Triple Tax Benefits with an HSA
A Health Savings Account is treated quite different than most other savings accounts -- primarily because it is explicitly intended to help with the high costs of healthcare. As a result, an HSA gives you the following tax breaks:
Contributions - While many savings accounts and IRAs do not offer any form of contribution tax deductions, a Health Savings Account does. Whenever you make a deposit, these funds are tax-deductible.
Growth - HSA accounts can be invested! Most if not all HSA providers allow the funds inside your account to be invested. As the investments grow, the growth occurs in a tax-free environment. This way, your HSA works just like any other retirement account.
Withdrawals - Finally, when you’re ready to withdraw funds, you do not need to worry about paying any taxes, as long as you use the funds for medical expenses. For most people, the bulk of their medical expenses will occur during their retirement years.
Paying For Your Medical Expenses
While health emergencies and healthcare costs are unpredictable, for most people, the bulk of medical expenses come along after retirement. Whether you require a long-term care facility, medications, regular doctor’s visits, or surgery, an HSA account can help you pay for these expenses, tax-free.
This is why it is important to grow your HSA for retirement, so that you have the necessary funds to cover your healthcare costs comfortably.
What if you need to withdraw these funds for reasons OTHER than medical expenses? As long as you withdraw the funds after age 65, they can be withdrawn penalty-free. If you don't use the funds to pay for qualified medical expenses, however, the funds you withdraw would be taxed as ordinary income. While this may seem like a bad deal, it's actually the exact same tax treatment as your 401(k) or Traditional IRA contributions are getting anyways. The money goes in tax-deductible and would come out as ordinary income. Of course, if used for medical expenses, the funds will be tax-free on withdrawal as well.
That said, not all healthcare costs occur after the age of 65. Regular check-ups, vaccinations, medications, and various other expenses will be needed throughout your lifetime. However, taking funds away from your HSA to pay for medical expenses before your retirement can end up costing you much more. These funds need time to grow, and the longer you delay withdrawing them, the better off you will be for retirement.
What If I Die With Unused HSA Funds?
If you should pass away before you've used all the money in your HSA account, it's really not an issue. If you are still married and the beneficiary of your HSA account is your spouse, then the HSA is transferred directly to your spouse for continued use without taxation. If your beneficiary is a non-spouse, then the HSA funds would be distributed and taxed as income to the beneficiary of the account. Those funds, however, could be used to cover medical expenses of the account holder for up to 12 months after their death. This is an important consideration in wrapping up an estate.
How Should You Pay For Medical Expenses?
Once you’ve hit retirement, it makes sense to use your HSA funds for medical expenses. This way, you won’t have to pay any kind of taxes on your withdrawals. However, while you are young, it makes much more sense to find other assets to pay for your medical costs.
Naturally, this will require clever budgeting, as you will still want to maximize your HSA contributions at the same time.
Balancing medical costs, HSA contributions, and tax-free withdrawals can be tricky. It may require you to cut costs and eliminate a few non-essential expenses along the way. However, these sacrifices will pay for themselves in the end, as you will be able to have peace of mind that your medical expenses are covered and you can live out your retirement in comfort.
Have any questions or want to set up some time to discuss your personal circumstances? Visit our website at Afton Advisors and schedule some time to connect!