Medical expenses are no joke, and that is especially true for consumers saddled with high-deductible health plans (HDHPs). Since 2011, the rate of workers enrolled in HDHPs jumped from 11% to 29%, according to the Kaiser Family Foundation.
For people enrolled in one of these HDHPs, chances are they’re familiar with the HSA, which stands for health savings account. HSAs are useful, tax-advantaged savings vehicles that allow consumers to contribute pre-tax dollars to a fund they can use for out-of-pocket medical expenses.
What HSA users may not realize, however, is that they can also hack their HSA and transform it into a tool for future retirement savings.
Before we explain further, you need to understand how HSAs normally work and who can take advantage of them. From there, you can use a strategy that allows you to use your health savings account as a powerful retirement tool that will help you manage your biggest expense once you retire.
How to Invest Through a Health Savings Account (HSA)
Health savings accounts allow you to contribute a set amount each year. As an individual, you can contribute up to $3,400 for 2017. Families can contribute up to $6,750, and the catch-up contribution for those over 50 allows you to put in an additional $1,000.
The money you contribute is tax free, meaning it reduces your taxable income in the current year. Once your money is in an HSA, you can hold it in cash or invest your savings to increase its earning potential. If you choose to invest, you can explore a variety of options.
But before you get too excited about the possibilities here, remember: not everyone gets access to HSAs. As we noted before, you need to have a high-deductible health plan before you qualify to open one of these accounts, which may or may not make sense for your financial situation.
You don’t have to use the HSA provider associated with your employer’s health insurance company, says Mark Struthers, a Certified Financial Planner and certified public accountant with Sona Financial.
“HSAs are individual accounts that don’t have to go through your employer. You can shop around for the lowest fees and best investment options,” Struthers says. And unlike their close cousin the Flexible Savings Account, HSAs are portable, meaning you can take your HSA with you if you leave the employer you opened it with.
Within the HSA itself, explains Struthers, you also get to choose many types of investments. “In addition to low-risk, savings-type accounts, you can invest in the same type of fixed income and equity mutual funds that may be in your 401(k) or IRA,” he says.
Just like all other investments, protecting against the risk of losing your hard-earned money is an essential step to take. Tony Madsen, Certified Financial Planner and president of New Leaf Financial Guidance recommends taking a hybrid approach.
“I typically advise my clients to leave two years’ worth of the maximum out-of-pocket expenses in cash in their HSAs,” Madsen explains. “Then, we include the rest in investments that are in line with the client’s overall retirement allocation.”
When you’re ready to withdraw your HSA contributions or your earnings, you can do so without penalty — and again without paying tax — anytime, so long as you spend the money on qualified health care expenses.
Examples of qualified expenses include doctor’s fees and dental treatments, vision care, ambulance services, nursing home costs, and even services like acupuncture or treatment for weight loss. It also includes things like crutches, wheelchairs, and prescription drugs (but does not include over-the-counter medications).
Why HSAs Are Great for Retirement Savings
Here’s what makes your HSA such an attractive vehicle for retirement savings:
If you can contribute to your HSA, invest it wisely, and leave the money in the account just like you would leave the money in your 401(k) or IRA until retirement, you can build a sizable nest egg to use specifically on health care costs after you retire.
Not only will you have a fund for medical expenses, but it’s also money you can use tax free!
That’s a big deal, because health care will likely be your largest expense in retirement. Fidelity estimates couples retiring in 2016 can expect to pay up to $390,000 for medical expenses and long-term care during their golden years.
Health savings accounts are designed to help you pay for medical expenses, tax free. No other account offers so many tax advantages for savers.
You can contribute money to the account tax free. Then you can invest that money, and the earnings are also tax free. If you withdraw the money and use it on qualified health expenses, that money is free from tax too.
In addition to the tax advantages, the funds you contribute to an HSA roll over from year to year. That means you don’t have to spend what you saved until you choose to do so.
(This is different from a Flexible Spending Account, where funds are subjected to a use-it-or-lose-it policy. If you don’t spend the money you put into the account by the end of the year, you don’t get it back.)
And health savings accounts aren’t just liquid savings vehicles. You can invest money within them, often within the same kind of mutual or index funds that you might invest in within a Roth IRA or brokerage account.
When It Doesn’t Make Sense to Use an HSA for Retirement Savings
While HSAs can provide a great, tax-free way to save and pay for qualified medical expenses, your priority should be on selecting the best health care plan for your needs first and foremost. If an HDHP makes sense for you, then you can look at using a health savings account.
If you have an HSA already or currently qualify for one, the next step is to consider hacking it to make it work even harder for you. You can transform your account from a good way to manage medical costs into a tool that makes it easier to bear the brunt of your projected retirement expenses.
This strategy may not work if you currently feel overwhelmed with the cost of your health care and need to take advantage of the tax-free savings and spending power today, instead of waiting for retirement.
Because you’re already in a high-deductible health plan if you have an HSA, that also means you are liable for greater out-of-pocket expenses if you seek treatment.
At a minimum, HDHP deductibles start at $1,300 for an individual or $2,600 for a family. Many HDHPs come with deductibles that range upward of $4,000.
Unless you already have an emergency fund with at least enough money to cover the cost of your deductible should you need to pay it, taking on an HDHP can leave you in a bad financial situation if a serious medical concern arises.
Here’s what you need to think about and ask before you switch to an HDHP:
- Do you expect to spend a lot of money on health care expenses in the next 5 to 10 years? If you’re young and have no health concerns, your expenses will likely be low and manageable.
- Do you currently have room in your monthly cash flow for occasional unexpected or increased expenses? If your budget can handle a few doctor’s bills here and there, you may be able to handle health care costs with regular income while you’re young.
- Do you have an emergency fund, and if so, is it fully funded? Would paying your full deductible wipe out that savings? If so, you may want to create a bigger rainy day fund before you take on an HDHP.
- Will you save on premiums if you switch to an HDHP? Often the higher deductible can provide you with a lower monthly premium, which can help free up more money in your monthly cash flow to pay for health needs as they arise — but that’s not always the case, so compare plans before making decisions.
- Can you contribute a significant amount to your HSA? Switching to an HDHP just to get an HSA doesn’t make sense if you’re not close to making the maximum contribution to the account each year.
You can also use a tool created by Hui-chin Chen, Certified Financial Planner with Pavlov Financial Planning. She designed a decision matrix where you can input your own financial information and numbers, and see if an HSA makes sense for you based on that information.
If you’re already on an HDHP and like your plan or if you decide you want to switch to one, open an HSA and start saving. At the very least, you can save money tax free, invest it tax free, and use it tax free on qualified medical expenses.
And that’s a great situation, even if you can’t contribute money and leave it in the account all the way until retirement. If you’re able to contribute and let your savings compound until you retire, great! Use your HSA as a retirement tool to help you cover your biggest expected expense in life after work.
“A ‘good’ HSA decision is to have one and use the funds you saved as you need them,” explains Brian Hanks, Certified Financial Planner. “‘Better’ is maximizing your family contribution each year and using the funds as needed. A ‘best’ situation is to maximize your family contribution, not use the HSA account for medical expenses, and treat it as a second 401(k) or retirement account instead.”