Health Savings Accounts and Retirement Guide

Health savings accounts (HSAs) can play a dual role, helping you to manage near-term healthcare expenses and save for retirement at the same time. Learn how to get the most out of your HSA.
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Health savings accounts (HSAs) are growing in popularity – and not just because Americans need help meeting rising healthcare costs.

HSAs are remarkably versatile in that they make tax-free savings available for immediate medical expenses while also allowing you to accumulate savings tax-free to use for medical expenses in the future. That’s why Americans are increasingly recognizing that HSAs can also play a valuable role in helping to build long-term retirement savings.

The growth in HSA usage shows that Americans are catching on to these dual benefits:

Devenir Research, an investment firm that follows HSA trends, found that there were some 22.2 million active HSAs as of the end of 2017, representing a total of $45.2 billion. Those numbers represent a 170 percent increase in the number of accounts over just five years, and a 192 percent increase in dollars.

Despite this rapid growth, there is still more that Americans could do to take full advantage of the special tax characteristics and retirement wealth-building potential of HSAs. This guide is designed to help you get the full benefit available from an HSA by taking you through the following:

  1. How an HSA works
  2. Using an HSA to manage medical expenses
  3. Using an HSA to save for retirement
  4. Investing your HSA savings

How an HSA Works

An HSA is designed to work in conjunction with a high deductible health plan (HDHP). In fact, you are not eligible to participate in an HSA unless you also participate in a HDHP.

HDHPs help keep health insurance premiums low by excluding from coverage a certain amount of routine expenses. Current IRS rules define HDHPs as those with deductibles of at least $1,350 for individual coverage (or $2,700 for family coverage) and which cap out-of-pocket expenses at $6,650 for individuals and $13,300 for family coverage.

(Note: All IRS dollar limits mentioned in this article are subject to change from year to year.)

This means that, in any given year, people in HDHPs may face between $1,350 and $6,650 in out-of-pocket expenses, or twice those amounts if they have family coverage. While having people shoulder a portion of their routine medical expenses helps keep insurance premiums relatively low, many people might have trouble finding available cash for these out-of-pocket expenses.

That’s where Health Savings Accounts come in. HSAs allow you to make an annual tax-deductible contribution of up to $3,450 for an individual or $6,900 if you have family coverage. This money can be invested without taxation and is not taxed when you use it as long as you spend it on qualified medical expenses.

Annual tax-deductible contribution for individuals: $3,450

Annual tax-deductible contribution for families: $6,900

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Using an HSA to Manage Medical Expenses

A good first step to using an HSA to manage medical expenses is to look at what you spent on healthcare last year, whether covered by insurance or not.

If your health is pretty much the same as last year, it is reasonable to expect you’ll have to spend a similar amount this year.

If the savings on annual premiums offered by your employer’s HDHP option compared with a full coverage option is greater than your likely healthcare spending, then you are a good candidate for the HDHP.

To make sure you have enough money to meet out-of-pocket expenses under the HDHP, open an HSA and make regular contributions that project out to at least as much as your likely healthcare spending for the year. This will not only help you build up enough savings to meet out-of-pocket healthcare expenses, but you will be able to meet those expenses out of pre-tax money.

Thus, using an HSA in conjunction with an HDHP could save you on both health insurance premiums and taxes.

According to the Employee Benefit Research Institute (EBRI), two-thirds of HSA participants used their accounts for this purpose by making withdrawals during the year.

Using an HSA to Save for Retirement

Money in an HSA does not have to be spent down each year. What you don’t spend can be accumulated and invested to grow tax-free, allowing you to supplement your retirement savings.

The EBRI found that the average amount put into an HSA in 2017 was $1,119 more than the average of $1,725 which was withdrawn throughout the year. That means that the average HSA owner let some money carry over for the future. Since the typical HSA owner did not contribute as much as the HSA contribution limit in 2017, they could have taken even greater advantage of this tax-free-wealth-building technique.

A key reason for doing this is that, unlike money in retirement accounts, the money you accumulate in an HSA is not even taxed when you take it out, as long as you use it for qualified medical expenses. Even if your health care expenses are relatively low now, you should find that you have no problem eventually finding qualified medical expenses you can use your HSA savings to cover.

According to the U.S. Bureau of Labor Statistics, for a person 65 or over, healthcare represents 13.4 percent of total expenditures, more than twice what it represents for someone aged from 35 to 44.

In other words, some extra savings for healthcare expenses can come in very handy in retirement.

HSAs and 401(k) plans each have different strong points when it comes to building retirement savings. Don’t look at your HSA as a potential replacement for your 401(k) so much as something you can use in conjunction with a 401(k) to optimize your retirement savings.

>> Calculate your retirement savings needs: Use our retirement savings calculator

Investing Your HSA Savings

So how should you invest the money in your HSA? The answer to this question is affected if you are using that money both to meet near-term-healthcare expenses and to build wealth for retirement. That means you should split the way the money in the HSA is invested according to what its purpose is.

Preparing for Near-term Expenses

If you have estimated your out-of-pocket medical expenses for the coming year, you will want to keep that amount in a stable and liquid investment option. Basically, this will mean using this portion of the money like an interest-bearing savings or money market account that you dip into periodically.

In this case, the key is to find the most competitive interest rate offered by the liquid investment options available through your HSA.

Building Long-term Retirement Savings

Although the EBRI found that the average HSA balance is growing over time, 90 percent of HSA owners don’t invest the money in anything other than short-term liquid assets. In other words, the vast majority of HSA owners are not investing accumulated assets in a manner appropriate for long-term retirement savings.

The HSA balance you are accumulating beyond what you are likely to need for near-term healthcare expenses can help you build retirement wealth, so you should invest it the way you invest a retirement account like a 401(k) plan or IRA. This would typically entail having a significant amount of that money in growth-oriented investments like stocks.

HSAs are perhaps harder to understand than most savings vehicles because they have both short-term and long-term uses. However, the more you understand about HSAs, the more you’ll come to appreciate these dual uses and develop strategies to take full advantage of each.

More resources on HSAs:

Health or wealth: juggling HSA and 401(k) contributions

How to use a health savings account to build retirement wealth

9 savings accounts with sweet tax breaks

Richard Barrington has been a Senior Financial Analyst for MoneyRates. He has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications. Richard has over 30 years of experience in financial services. He has earned the Chartered Financial Analyst (CFA) designation from the Association of Investment Management and Research (now the “CFA Institute”).