An HSA is often used to help pay for medical expenses when they occur, but it can also be an excellent way to save for retirement.
The HSA is full of tax advantages that make it a great way to save both today and in the future. If you have a substantial HSA balance when it's time to retire, you're sitting in a great position. Here are three benefits of an HSA in retirement you don't want to miss out on.
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1. Tax-free growth
Like other retirement accounts, funds invested inside an HSA grow tax-free.
Any interest, dividends, or capital gains you earn in your HSA won't be subject to taxes. As such, you're able to reinvest the full amount of any investment proceeds, maximizing the growth of the account.
Planning your withdrawals from your various accounts in retirement is essential to maximizing your savings and minimizing your tax burden. The more money you can keep in tax-free growth accounts, the larger your portfolio will grow over time.
While you might have other retirement accounts like a traditional or Roth IRA that offer the same tax-free growth benefit, the HSA is a great way to get more money into tax-advantaged accounts.
2. Tax-free distributions for health expenses
On top of tax-free growth, you can likely get most of your investments out of an HSA without paying taxes on the distributions.
The HSA is designed to help people with high-deductible health insurance plans save money on their healthcare expenses. The way it does that is by effectively making those expenses tax-free through tax-free contributions to the HSA and tax-free distributions on qualified expenses. But you don't have to take that tax-free distribution at the time you incur the medical expense.
If you save your receipts from the time you establish your HSA, you can reimburse yourself at any time in the future, be that next year or next decade. Paying for medical expenses from other savings and then using those expenses to offset withdrawals in retirement can lead to years worth of tax-free spending from your HSA.
Not to mention you'll likely incur more medical expenses in retirement. You can even use HSA funds to pay for Medicare Part B and Part D and prescription drug coverage. If you retire early, you can use HSA funds to pay employer-sponsored health insurance through COBRA. You can also use the fund to pay for part of the cost of a tax-qualified long-term care insurance policy.
3. The emergency hatch
The worst-case scenario with an HSA is the best-case scenario with a traditional IRA.
Once you reach the age of 65, you can take a distribution from your HSA for any reason without the usual 10% tax penalty. If you don't have a qualified health expense to cover the distribution, you'll still owe income tax on the amount you withdraw.
Effectively, the HSA works like a traditional IRA in that instance. You get a tax deduction on your contribution, and the taxes get deferred until you withdraw your savings in retirement. The only difference is you have to wait an extra five and a half years to take funds from the HSA without qualified medical expenses.
This emergency hatch is what makes the HSA one of the most versatile accounts for saving for retirement. If you absolutely need to withdraw from the HSA in retirement, you still have a very tax-efficient way of getting those funds.
The ultimate retirement account
The HSA is possibly the best retirement savings vehicle you can use.
It has the advantages of tax-free contributions, tax-free growth, and tax-free withdrawals. And even if you can't get all the money out tax-free, you can still use the account for retirement spending without any penalties.
If you're not taking advantage of all the benefits an HSA has to offer, you're missing out on some big savings opportunities.
