As savings vehicles go, Health Savings Accounts, or HSAs, are rainy day funds with generous benefits.
The funds are tax-advantaged accounts that have been available since 2003 to taxpayers with high-deductible health plans (currently plans with deductibles of at least $1,300 for individuals and $2,600 for families). They were intended to cover out-of-pocket medical expenses, yet HSAs have lesser-known advantages. They can be used to supplement retirement savings, providing tax benefits not only when you contribute but also, in many cases, when you withdraw money. You can also take them with you if you change jobs.
The Internal Revenue Service limits the amount of HSA contributions and deductions, as it does with all tax-deferred vehicles. For 2015, taxpayers with individual medical coverage can invest and write off $3,350. For those with family coverage, the limit is $6,650. Each year, those limits are adjusted to reflect consumer inflation.
As employers have increasingly passed on more out-of-pocket medical expenses to employees, HSAs have become popular additions to workers’ benefits. As of the end of 2014, there were more than 10 million HSAs, with assets of $22 billion compared with 4 million accounts with $6 billion in assets in 2008, according to the Employee Benefit Research Institute. Fifty million Americans will have health savings accounts in four years, predicts the Institute for Healthcare Consumerism, an industry group, although only 15 percent of HSA holders make the maximum yearly contribution today.
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Useful for retirees
Unlike flexible spending accounts for medical and dependent care expenses, with which HSAs are sometimes confused, health savings accounts do not have to be emptied every year. The money in them can accumulate and grow year to year if not spent. If used for medical bills, HSA withdrawals are tax free; if used for other purposes, a 20 percent penalty is charged, but not if the account holder is 65 or older. That is what makes the accounts useful for retirees. They offer attractive saving and spending options.
Not only can you enjoy tax-deferred benefits when you contribute to an HSA, you also do not have to start withdrawing money in a “required minimum distribution” at age 70-1/2 as you do with other retirement accounts. You can leave the money in as long as you like.
If you don’t need to use HSA money for out-of-pocket medical expenses, you can use it to back up other savings.
“For those who are qualified to use them, HSAs behave in the same way as tax-deferred IRAs,” says Wade Pfau, professor of retirement income at the American College of Financial Services in Bryn Mawr, Pa.
“They have the extra benefit that if the withdrawals are for qualified medical expenses, then no taxes are due. So in a sense, they are supercharged IRAs and should even take a higher place than an IRA in one’s hierarchy of funding priorities with savings.”
Let’s say you start an HSA and deposit $5,000 in it. You are married with family coverage with a high-deductible plan and contribute $100 a month in addition to the $5,000, and the account grows at a modest 4 percent a year.
Your savings would total nearly $22,000 after 10 years. That assumes that you did not need to withdraw the money in the interim for medical expenses. The longer you keep the money in, the higher the total can become.
Although the accounts have several tax benefits, you will need to be careful how you invest the money in an HSA, just as you would with any other retirement account.
You will need to beat inflation to keep up with the cost of living, so it probably makes little sense to invest in money market funds or low-yielding bonds, unless you simply want to avoid higher-risk stock funds and protect your principal.
The main drawback of the HSA is that it is available only to people with high-deductible health policies. You cannot open an HSA independently if you have other coverage or if you are already enrolled in Medicare. But if you can open one, and contribute to it, the account can be a useful fail-safe in your older years.