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Health Savings Accounts Can Save You More for Retirement Than You Know

Here's how to maximize the investing and tax benefits of a health savings account, or HSA.

When it comes to saving (and investing) for healthcare expenses in retirement, there is perhaps no better option than a health savings account or HSA.

Why so? In essence, it’s the tax advantages:

  • One, the contributions are pre-tax if you’re contributing via payroll deduction or tax deductible if you’re contributing post-tax money.
  • Two, the money grows tax-free.
  • And three, HSA money used to pay for qualified medical expenses is always free from federal income taxes. And those medical expenses include long-term care insurance, Medicare Part A or B, Medicare HMO and employer-sponsored retiree health insurance premiums.

Of course, not everyone can open an HSA. According to the IRS, to be an eligible individual and qualify for an HSA, you must meet the following requirements:

  • You are covered under a high deductible health plan (HDHP), described later, on the first day of the month.
  • You have no other health coverage except what is permitted under "other health coverage", described later.
  • You aren’t enrolled in Medicare.
  • You can’t be claimed as a dependent on someone else’s 2020 tax return.

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Contribution Limits

And as with most retirement plans, there are contribution limits. The annual limit on HSA contributions for 2021 is $3,600 for self-only and $7,200 for family coverage, according to Revenue Procedure 2020-32. Those age 55 and older can contribute an additional $1,000 to their HSA.

The IRS also just announced inflation adjustments for HSA contributions for 2022. Individuals with self-only coverage in a high-deductible health plan will be able to contribute up to $3,650 in an HSA in 2022. Those with family coverage can save a maximum $7,300 next year.

At the moment, most HSA account owners seemingly use the money in their accounts to pay for current medical expenses, and the bulk of the money is invested in safe interest-bearing investments.

But 4% of HSA account owners are investing their money in mutual funds in hopes of building a nest egg large enough to pay for some or all healthcare costs in retirement, which can be considerable when viewed as a present value.

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The Employee Benefits Research Institute, for instance, estimates that a couple age 65 would need $168,000 set aside in order to have a 50/50 chance of sufficiently covering medical premiums and median prescription drug expenses in retirement and $270,000 to have a 90% chance of paying for those costs.

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Saving for Future Healthcare Costs

So, when might you consider investing the money in your HSA for healthcare expenses in retirement?

According to Keith Whitcomb, director of analytics at Perspective Partners, it makes the most sense if you have enough money set aside -- either in the HSA or elsewhere such as a 401(k) loan, a HELOC or emergency fund -- to cover planned medical as well as unexpected medical events.

If you don’t need the HSA for payment of any current medical expenses, Whitcomb recommends saving all receipts from the qualified medical expenses you pay for out of pocket with after-tax funds. By doing this, “you maximize the investing benefits of the HSA, and effectively create a cash reserve usable for any purpose based on the cumulative value of the saved receipts,” he wrote in a recent Retirement Daily article.

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Another item to consider if you're saving money in an employer-sponsored HSA and you are also saving for retirement in an employer-sponsored retirement plan such as a 401(k) is this: The order and amounts to save to each account.

Fidelity Investments, for instance, recommends the following:

  1. Consider contributing enough to get your full employer match in your 401(k), and set aside enough for this year’s medical expenses in your HSA.
  2. Once you’ve saved enough to get your employer match in your 401(k) and cover your healthcare expenses in your HSA, you can focus on maxing out your HSA.
  3. Once you’ve maxed out your HSA contributions, focus on contributing up to the maximum in your 401(k) as well.

Read more about How to Fund Your HSA and 401(k).

So how might you invest the money in your HSA? The first thing to know is that your HSA is under your control, according to Whitcomb.

“Just like your checking, savings, and brokerage accounts, you can open and close health savings accounts at other institutions, and even have multiple HSAs,” he wrote.

So, if your current HSA does offer an option to invest your funds or has a limited menu of investment alternatives, consider using another HSA.

Next, think about your asset allocation. According to Whitcomb, the asset allocation strategy for your HSA should be similar to your other long-term accumulation accounts. And, as you near retirement he recommends that you may want to prepare the account to handle the liquidity needs of your retirement medical expenses.