Health savings accounts (HSAs) are highly underrated and underused, in our opinion. Many people don’t understand the significant impact these accounts have on offsetting retirement income, as well as the long-term
The fact that many people don’t understand the value of opening an HSA early in life pretty much robs them of the chance for creating this critical long-term income growth. The ability for gains to grow tax-free is significant, and over time, builds funds in the account that can be used in retirement for qualified health care costs, including some Medicare premiums.
There are many benefits of owning an HSA, which we’ll get to later in this article. But, the top 3 reasons you should open an HSA today are found in the triple-tax advantage that only these savings plans offer.
1. You get a tax deduction for making contributions to an HSA
And here’s the thing—the contribution limit for a family plan is much higher than that of a traditional or Roth IRA. You’re looking at the ability to contribute $6,850 into a family plan as compared to only $5,500 to the aforementioned IRAs.
While the individual contribution limit is a bit less ($3,450) you are able to deduct the contributions on your taxes. Yes, you can also do so if you have a traditional IRA, but not with a Roth account. Additionally, there is a provision for those 55 years of age and over that allows an extra $1,000 contribution each year.
2. Gains in health savings accounts grow tax-free
This is one way the investment potential in HSAs can be lucrative. When you open an HSA early in life, the long-term investing potential alone allows paves the way for growth in the account that can tremendously offset your retirement funds when it comes to covering ever-rising medical costs.
Accounts that only accrue short-term growth will not last long enough in retirement, meaning you’ll have to dip into your retirement funds to cover expensive medical costs. Depending on your situation, you could take quite a hit to your yearly retirement plan income should you have unforeseen health issues. A healthy (wealthy) HSA alleviates that burden and helps you enjoy your retirement without financial worries.
3. Withdrawals from an HSA are tax-free when used for qualified medical expenses
Depending on the retirement account you have, distributions—even for health care—are taxed. However, withdrawals from health savings accounts are not taxed as long as they are spent on qualified medical expenses. If you pay for non-qualified expenses or withdraw funds from your HSA for any other reason, you’ll be taxed on those withdrawals. And, if you’re under the age of 65 and withdraw funds for reasons other than qualified medical expenses, you’ll get hit with a 20% penalty along with that tax liability.
But, let’s not stop with the top 3 reasons you should open an HSA. There are a few other notable benefits you should know.
- HSAs do not have required minimum distributions (RMDs).
- Withdrawals from HSAs are not counted towards your yearly income, which can help you maintain a satisfactory income bracket in retirement when making withdrawals to pay for health costs.
- You can pay for Medicare premiums such as Parts B, Medicare Advantage plan (Part C), a prescription drug plan (Part D), and long-term care insurance on a tax-qualified basis. Here you gain the potential to save a bundle if you use your HSA funds for these costs instead of taxed funds.
- After 65 years of age, you can withdraw funds from your HSA to use for purposes other than medical expenses without incurring a penalty. (However, you will be taxed on those withdrawals.)
As you can see, the advantages of health savings accounts are undeniable. If you take into account the number of health issues we are subject to the longer we live—the benefits of establishing an HSA to cover qualified health-related costs are quite significant, indeed. It always helps to be prepared and using an HSA provides an incredible financial tool for you in your golden years.
This material was prepared for Sheri Pan's use.
LPL Financial does not provide tax advice. Clients should consult with their personal tax advisors regarding the tax consequences of investing.