Have you ever wondered what the best method for tax-advantaged savings is? Some industry experts suggest maxing out your health savings account (HSA) before funding your 401(k) or IRA. Of course, it is important to factor in your company’s 401(k) match to ensure you are getting the most from your employer, but as future healthcare expenses are inevitable, funding an HSA could be as important to your retirement plan as your 401(k).
There has been a lot of hype surrounding HSAs in the past few years as their popularity continues to grow. Questions about HSAs have also continued to grow. HSAs were approved by Congress in 2003 so that individuals with high-deductible health plans could receive tax-preferred treatment for saving money for future healthcare expenses. Unlike any other savings vehicle, if the funds are used for qualified medical expenses, there is no tax liability. The money goes in pre-tax, continues to grow tax-deferred, and comes out tax-free. What other savings vehicle offers all three?
To be eligible for an HSA, you must be covered by a high-deductible health insurance plan and not be enrolled in Medicare or any other non-high-deductible health coverage. A high-deductible plan for 2023 must have a minimum deductible of $1,500 for single coverage or $3,000 for family coverage. These plans generally have lower premiums than other health insurance options, and as an incentive for having a high-deductible health plan, many employers will contribute to their employees’ HSAs. Keep in mind any amount an employer puts into your HSA counts toward the contribution limit. The maximum contribution to an HSA for 2023 is $3,850 for an individual and $7,750 for a family. For those age 55 or older, there is an additional $1,000 catch-up contribution.
Besides going in pre-tax, growing tax-deferred, and being distributed tax-free when used for qualifying medical expenses, HSA funds can be rolled over from one calendar year to the next. If you don’t use it, you don’t lose it like you do with flexible spending accounts. You also do not have to withdraw money from an HSA in the same year in which an expense occurs. You can have a qualifying claim today, pay for it out of pocket, and reimburse yourself years later. In the meantime, you will continue to accumulate growth and interest on the funds that remain in the HSA.
Many HSA custodians allow you to invest your HSA funds, giving them the opportunity to grow at a comparable rate to your other investment accounts. Funds from HSAs can be used at any age for qualified medical expenses, and there are no required minimum distributions like there are with IRAs. If you are at least age 65 and decide to withdraw any amount from your HSA to use for non-qualified medical expenses, you may do so penalty-free. Prior to age 65, if funds are not used for qualified medical expenses, a 20% penalty applies. Anytime you withdraw funds from an HSA for non-qualified expenses, ordinary income taxes apply.
There are many reasons HSAs are one of the most effective savings vehicles available. This does not mean you should exclusively fund an HSA, but the fact remains that contributing to an HSA has the potential for more beneficial tax treatment than any other type of account. Medical expenses are a certainty, so why not fund one of the best vehicles for handling them on your road to retirement?
Stifel does not provide legal or tax advice. You should consult with your attorney and tax advisor regarding your particular situation.