How to Maximize HSA Savings With Your IRA and 401(k)
Given the rising costs of healthcare -- the America’s Health Insurance Plans (AHIP) estimates that the U.S. healthcare system spends $2.7 annually -- having adequate savings for current and future healthcare costs are key. Even with the “affordable” health insurance covered instituted by Obamacare, most people can assume that as they get older, their healthcare costs will increase.
The good news is that Health Savings Accounts (HSA) can help offset some of today’s costs -- as well as those you may encounter as you get older. An HSA savings works in conjunction with a high-deductible health insurance policy. It is a special savings account that you and/or your employer fund to cover deductibles, copays and qualified medical expenses. As the burden is now placed on individuals covering more of their healthcare costs through increased deductibles and copays, an HSA can make smart financial sense.
What are HSAs?
HSAs are individual financial accounts that are portable and intended to follow you from employer to employer to help you manage healthcare spending and saving. Unlike other healthcare spending accounts, such as flexible spending accounts, HSAs don't “go away” so people can hold them through retirement.
The question is: should you take the time to fund an HSA for a year, over contributing to your retirement account? Or can you achieve your goals for adequate healthcare coverage as well as your future retirement needs?
Sean Moor, a Certified Financial Planner and Chartered Financial Consultant says, “I use an HSA for my family and encourage any clients that have the ability to use one to do so.”
In his view, ideally, one would use an HSA in addition to their retirement plans rather than missing out on the benefits of a retirement plan’s compounding interest and ability to make tax-free contributions. “However, there are certainly scenarios where the HSA would be more beneficial if you could only choose one plan,” he notes.
Situations in which Moor recommends funding an HSA before a retirement plan include:
- To pay for prescriptions
- To cover a planned medical expense, such as surgery
- To pay for maternity costs
- To pay for services not covered for a chronic illness
- To pay for qualified medical equipment
- To supplement poor or lack of dental coverage
The difference between HSAs and retirement accounts
Both retirement accounts and HSAs have significant advantages, as well as some disadvantages. Before you decide that one savings option is better than the other, you should carefully compare the specifics of your current retirement plan with your HSA and make sure to keep in mind your personal financial situation and goals.
“If your health savings account only offers you a low interest savings account versus the option to invest your money for a higher potential return or if your HSA has high fees such as monthly or transaction fees, then you may want to consider saving more in your retirement account,” says Ann Arceo, AAMS.
On the other hand, she notes, if your retirement account features high fees and few investment choices, then it may be worthwhile to contribute more to an HSA that has low fees, good investment options, as well as potential tax savings. Make sure to take advantage of any employer match on your retirement account before putting money into an HSA.
Withdrawal rules are different
One thing to keep in mind is that the withdrawal rules are different for HSAs than for retirement accounts. You can withdraw the money from an HSA at any time to pay for qualified medical expenses, however, if you want to use the money for something other than qualified medical expenses then you’ll be hit with a 20 percent tax penalty unless you are 65 or over.
After age 65, in order for a withdrawal to be tax-free, it needs to be used for qualified medical expenses or the funds will be taxed as income. Once you are in Medicare, you can no longer contribute to the HSA, but you can use the money on insurance premiums, including Medicare and Medigap policies. With a retirement account, you can begin taking penalty-free withdrawals at age 59½. Depending on the type of retirement account you have, your withdrawals may be taxed as income.
Investment Strategist Tim Shanahan explains that his strategy is to use an HSA paired with a high-deductible medical plan with the objective to use the HSA as either a supplemental retirement account or to be available during retirement for qualified health costs. “I fully fund the plan each year and invest the funds into mutual funds and securities that have growth potential,” he explains. “I have not spent any of my HSA. I also fund my SEP IRA as it has much higher limits for 2021 ($58,000 including the over 50 versus $8,200 in the HSA including the over 50).”
To open an HSA savings, you must be covered by a high-deductible plan. While these policies generally charge the lowest premiums, they also require the largest upfront costs before the insurance company will pay any medical expenses. The deductible for 2021 must be at least $1,400 for an individual policy and $2,800 for a family policy. You can find HSA-compatible policies on the state and healthcare exchanges, as well as through individual insurers and through employer-sponsored plans.
If you’re considering an HSA, here are some tips:
Maximize your match
The employer match is one of the few benefits perks still available. Try to max out your HSA and your 401(k) to take advantage of your employer’s contribution.
Investigate your investment options
Just like with a 401(k), your employer HSA plan may offer only expensive mutual fund options. Explore other HSA and their associated banking and investment options to see how you can maximize your savings while minimizing your account expenses.
Be sure to use it
While an HSA is tax deductible, the benefits won’t last forever. Now is a good time to consult with your tax or financial advisor to see how an HSA will be treated in your estate should you pass it on to your heirs.