Health Savings Accounts and Investing
A health savings account (HSA) is a medical savings account for people with high-deductible health plans. You pay no income tax on the money you place into your HSA until you withdraw it. The tax advantage makes HSAs a useful retirement planning tool now while planning for future medical expenses.
What Is a Health Savings Account?
A health savings account, or HSA, lets you set aside money for certain medical costs, including deductibles, coinsurance, copayments and other qualified expenses. Most health savings accounts cannot be used to pay for insurance premiums.
The money you and your employer put into your HSA is not counted as income for tax purposes, so you maximize your investment in the account while avoiding income taxes on your contributions.
HSAs are only available to people who have high-deductible health insurance plans. The Internal Revenue Service defines high-deductible plans as having a deductible of at least $1,400 for an individual or $2,800 for a family in 2020.
High-deductible plans usually charge higher deductibles in exchange for lower monthly premiums. Somewhere between 23 million and 36.8 million Americans — employees and their dependents — were covered by high-deductible policies in 2018, according to the Employee Benefit Research Institute.
How to Set Up a Health Savings Account for Retirement
To qualify for an HSA, you first have to be enrolled in a high-deductible health plan. You’ll have to open a separate health savings account.
You may be able to set up an HSA through your employer if your job offers one. If it doesn’t, you may find plans in the health care marketplace or through health insurance companies. You may also be able to set up an HSA through your bank.
Once you enroll in an HSA, you will receive a debit card or checks you can use to pay for qualified medical expenses your insurance does not cover.
How you deposit contributions to your HSA and banking services to monitor and maintain your account can differ depending on the insurer or financial institution you choose.
HSA Retirement Benefits and Tax Advantages
A health savings account can give you immediate tax advantages while allowing you to build substantial savings to pay for medical expenses throughout your career and into retirement.
HSAs have become a popular retirement planning tool because of their tax advantages and investment potential since they first became available in 2004. By the end of 2018, there were 9.8 million HSAs in the United States worth $22.8 billion, according to the Employee Benefit Research Institute (EBRI).
- If you have an HSA through your employer, you pay no income taxes on your contributions.
- If you set up your own HSA, all your contributions are tax deductible.
- You do not have to pay taxes on any money to withdraw for qualified medical expenses.
- You do not pay taxes on the growth of your HSA.
Unlike a flexible spending account, or flex account, money left in your HSA at the end of the year can be rolled over into the next year. EBRI estimates that 93 percent of HSAs ended 2018 with money left to roll over for future medical expenses.
Over the course of your career, annual rollovers could add up to substantial savings.
Investing Strategies for a Health Savings Account
There are several investment strategies for getting the most out of your health savings account.
- Max out contributions
- Avoid spending from your account when you can
- Consider investments carefully
- Take advantage of family and employer contributions
Taking advantage of these strategies requires you to consider your HSA as one element of your retirement planning toolbox rather than just a way to cover unexpected medical expenses.
Make Maximum Contributions
Maxing out your HSA contributions before you turn 65 is one of the ways to grow your account. Your contributions are tax deductible or tax free, depending on your plan, until you sign up for Medicare.
You are allowed to contribute up to $3,550 a year for self-coverage or up to $7,100 for family coverage in 2020. The maximum amount may be adjusted for inflation each year.
Avoid Spending from Your Account
If you can pay for medical expenses without touching your HSA, you will improve the account’s potential for growth toward retirement.
Also be aware that if you spend any money from your HSA on anything that is not a qualified medical expense under your plan, you will have to pay a 20 percent penalty and income tax on the money you withdraw.
Consider Your Investment Options
Unlike a standard low-interest savings account, some HSAs allow you to invest in mutual funds, individual stocks or exchange-traded funds (ETFs).
Any profits you make from these investments are tax-free, so long as you use them to pay for qualified medical costs.
Take Advantage of Family, Employer and Catch-Up Contributions
Contributions to an HSA set up through your employer can come from you, your employer or both. Any contributions from your employer do not count as income, so it’s not taxed. Like employer contributions to a 401(k) plan, this is like receiving free money.
If you’re 55 or older, you can take advantage of catch-up contributions as you get closer to retirement. This allows you to contribute an extra $1,000 a year. Your spouse can also contribute an extra $1,000, but your total family contribution cannot exceed $9,100 in 2020.
How Your HSA Works With Medicare
You can no longer make tax-free contributions to your health savings account for up to six months before you sign up for Medicare.
You should take this into account if you plan to work past your 65th birthday. If you decide to keep your group health insurance through your job and enroll in Medicare, you will be hit with a tax bill for your HSA contributions.
But you can use the money you’ve saved in your HSA to cover medical expenses Medicare does not.
- Medicare Part B medical insurance premiums
- Medicare Part D prescription drug coverage premiums
- Dental care
- Hearing aids
- Insulin and diabetic supplies
- Over-the-counter drug costs
- Prescription medicine
- Vision care
You cannot use money from your HSA to pay premiums for Medicare supplemental insurance, also called Medigap. This is not considered a qualified expense and will result in a 20 percent penalty, and you’ll have to pay income taxes on the money you use to make the payment.
8 Cited Research Articles
- U.S. Internal Revenue Service. (2020, February 18). Publication 969 (2019), Health Savings Accounts and Other Tax-favored Health Plans. Retrieved from https://www.irs.gov/publications/p969
- Linecker, A.C. (2020, February 18). HSA Investment Advice for 2020: Think Twice Before Spending HSA Funds. Retrieved from https://www.investors.com/etfs-and-funds/personal-finance/hsa-investment-advice-hsa-funds/
- U.S. Internal Revenue Service. (2020, January 21). Publication 502; Medical and Dental Expenses (Including the Health Coverage Tax Credit). Retrieved from https://www.irs.gov/pub/irs-pdf/p502.pdf
- Fronstin, P. and Spiegel, J. (2019, December 5). Health Savings Account Balances, Contributions, Distributions, and Other Vital Statistics, 2018: Statistics From the EBRI HSA Database. Retrieved from https://www.ebri.org/health/hsa-database/content/health-savings-account-balances-contributions-distributions-and-other-vital-statistics-2018-statistics-from-the-ebri-hsa-database
- Mayo Clinic. (2019, March 16). Health Savings Accounts: Is an HSA Right for You? Retrieved from https://www.mayoclinic.org/healthy-lifestyle/consumer-health/in-depth/health-savings-accounts/art-20044058
- U.S. Department of the Treasury. (2015, December 1). Health Savings Accounts (HSAs). Retrieved from https://www.treasury.gov/resource-center/faqs/Taxes/Pages/Health-Savings-Accounts.aspx
- HealthCare.gov. (n.d.). Health Savings Account (HSA). Retrieved from https://www.healthcare.gov/glossary/health-savings-account-hsa/
- HealthCare.gov. (n.d.). Setting up HSAs. Retrieved from https://www.healthcare.gov/high-deductible-health-plan/setting-up-hsa/