When you’re in your 20s and in good health, planning ahead for long-term medical costs is probably the last thing on your mind but there’s a good reason to give it a second thought. If you’re enrolled in a high deductible insurance plan that includes a Health Savings Account, you’ve got access to a valuable savings resource.
A Health Savings Account or HSA is a tax-advantaged account that makes it easier to keep up with the rising cost of healthcare. You set aside pre-tax dollars and tap the account any time you need to cover things like deductibles or out-of-pocket care that isn’t covered by your insurance. While these accounts are designed with health care in mind, that’s not the only way they can be used.
If you’re a 20-something who doesn’t anticipate having a lot of high medical costs, fitting an HSA into your retirement strategy is a smart move. As long as you stay healthy, you can build your nest egg at a more aggressive rate. Making the most of your health savings account is relatively easy, as long as you know how to use it wisely.
1. Use it as a stop-gap
Research shows that about 70 percent of millennials (meaning those in the 18 to 34 range) are saving for retirement, either through an employer’s plan or an individual retirement account. While that’s definitely encouraging, that means 30 percent of 20- and 30-somethings aren’t saving a dime. For some, the issue is a cash flow problem but for others, it’s simply a lack of options. If you’re not able to save for retirement through an employer’s plan, an HSA is the perfect short-term solution.
Here’s an example to show you what we mean. Kate is 22, has recently graduated and is starting a new job. Her employer doesn’t offer a 401(k) but she’s eligible to participate in a health savings account. She saves $3,350 each year (the current contribution limit for single coverage) for five years before moving on to a different company. At the end of her tenure, her balance would be nearly $21,000, assuming a 7 percent annual return. That’s not a bad payoff for a relatively small investment.
Did you know? An estimated 15.5 million Americans are enrolled in a high deductible/health savings account insurance plan.
2. Use matching contributions to your advantage
As an incentive to encourage employees to participate, some employers will match the contributions you put in to your HSA. The total amount you and your employer chip in can’t be more than the annual contribution limit. For a 20-something who’s not making a lot or who can’t afford to save the full amount because they’re trying to wipe out student debt, scoring the match is a no-brainer.
How much you’ll need to save depends on the employer. Some companies may limit their HSA match to 10 percent, while others may go as high as 100 percent. If our new grad Kate lucks out and is able to snag a 100 percent match, she’ll only have to save $1,675 for the year, which frees up some extra cash she can use to attack her debt or open an online savings account for her emergency fund.
3. Max it out on top of your 401(k) or IRA
If you’re making some big bucks and you’ve got a 401(k) or IRA, an HSA can be the icing on your retirement savings cake. The IRS allows you to contribute the full amount to each of these accounts in the same tax year with no penalty. For 2015, the cap on 401(k) contributions is set at $18,000 and you can put an extra $5,500 into an IRA.
Let’s assume that Kate eventually lands a plum gig making $100,000 a year. She doesn’t have any debt and her expenses are low so she can afford to funnel a big chunk of her income into savings. She maxes out her 401(k), along with a Roth IRA and her HSA to the tune of $26,850, not including whatever her employer matches. If she can do that every year for 10 years, she’d have more than $250,000 saved, not counting anything her employer puts in. Even better, the money she puts in her 401(k) and health savings account is tax-deductible, which means she could owe less or get a bigger refund when it’s time to file.
Did you know? More than 50 percent of those eligible to participate in an HSA plan are under 40.
4. Leave it alone until you need it
One of the best things about an HSA is that you’re not required to spend the money you save up, the way you would need to with, say, a flexible spending account. That means that as long as you don’t have any pressing medical needs, you can just leave it alone. Unlike an IRA or 401(k), there are no minimum distribution requirements once you reach a certain age, so you can basically let the money sit and continue to grow.
It’s possible to use the money for non-medical expenses but there are some tax rules to keep in mind. For instance, say Kate decides to buy a house and she wants to use the $20,000 she’s built up in her HSA for the down payment. Because she’s under 65, she’ll have to cough up a 20 percent penalty, plus pay taxes on the money at her regular rate. If she were to hold on to the money and apply it to Medicare premiums or other qualified medical expenses later in life, she’d be able to take it out tax and penalty-free.
The bottom line
The benefits of a health savings account go far beyond retirement, especially for 20-somethings who aren’t sure where to start with planning for the future. The key for young adults is to understand how they work so you’re getting the most mileage out of every dollar you save.