Why You Should Wait Until You Retire to Dig into Your HSA

You have access to a variety of benefits as part of your employee benefits package, including health insurance, a 401(k) plan, and possibly even stock options. However, the most beneficial option may also be the most underutilized: a health savings account (HSA).

A health savings account (HSA) is a type of savings account that allows you to put money aside before taxes to pay for qualified medical expenses. They also have special tax advantages that make them work as a second retirement account. So, while you may have been told that your HSA should only be used for medical expenses (which is correct), there are several advantages to simply waiting until your HSA funds are depleted to retire.

How Do HSAs Work

HSAs are tax-advantaged medical savings accounts that combine the best features of both a Traditional and Roth IRA to save you money on a wide range of health-care expenses—including many that aren’t covered by insurance. You get an immediate tax deduction on contributions, just like a Traditional IRA. Any earnings and distributions are tax-free, just like a Roth IRA, as long as they’re used for qualified healthcare expenses. Those distributions are subject to a 10% penalty if they aren’t used for qualified medical expenses.

Because HSA contributions are made before taxes, you are effectively putting a portion of your tax bill into your health savings account. Assume you’re in the 24 per cent tax bracket and want to contribute $100 to your HSA every month. That $100 would normally result in a $24 tax bill, leaving a net of $76. You can think of your $100 contribution as a $76 contribution, with the remaining $24 being a tax bill. You won’t have to pay that bill as long as you use the account’s distributions to pay for qualified medical expenses.

The money you save in an HSA can accumulate from year to year, unlike a flexible spending account (FSA), which is another type of medical savings account offered in conjunction with your health care plan. This allows you to build up your account balance during years when your medical expenses are lower. Furthermore, because you, not your employer, own the HSA, the money in it is yours to keep for the rest of your life. Even if you don’t have a lot of medical expenses right now, the benefits are so great that there’s no reason not to open an HSA and contribute to it if you’re eligible and the contributions fit into your budget.

How Do I Know If I’m Eligible for an HSA?

You must be enrolled in a high-deductible health plan (HDHP) to contribute to an HSA, and you cannot be claimed as a dependent on someone else’s tax returns. You won’t be able to contribute to your HSA after you enroll in Medicare because it isn’t classified as an HDHP, but you will still be able to use the funds from your HSA for medical expenses.

Why Should I Wait Until Retirement to Use My HSA?

The ability to save more through compounding interest and the ability to be better prepared to pay for your expenses in retirement are the two main reasons why you should wait to use your HSA until your retirement years.

Save More by Compounding Interest

Consider the following scenario: Person A contributes $1,500 to an HSA each year, but only uses $500 for medical expenses, resulting in a net contribution of $1,000. Person B also contributes $1,500 per year but pays the $500 in annual medical expenses with money from a checking account. Person A would have about $36,800 in an HSA after 20 years if we assume a 6% rate of return, while Person B would have about $55,200. While this is a hypothetical scenario, it demonstrates the importance of allowing your money to grow for as long as possible.

Be Better Prepared to Pay for Expenses

Perhaps even more important than the ability to save more, keeping your money in your HSA will better prepare you for the road ahead. Many people consistently underestimate the cost of health care. According to the Employee Benefits Research Institute, retirees’ healthcare costs are typically much higher than they anticipated, with estimates for healthcare spending in retirement approaching $200,000—and which does not include the costs of long-term care. These figures demonstrate the importance of putting money aside for post-retirement medical expenses, and by not using your HSA during your working years, you can save that money for a time when health care costs are likely to be a much larger part of your budget.

Even if your medical bills are unusually low in retirement, the money in your HSA can be used to cover other living expenses. The 10% penalty for non-qualified medical expenses is eliminated once you reach the age of 65. So, if your furnace breaks down or your roof needs to be replaced, you can use your HSA to cover the costs. Those distributions that aren’t used for medical expenses, however, will be subject to regular income taxes. In essence, your HSA can be compared to a Traditional IRA with the added benefit of tax benefits during retirement.

How We Can Help

It’s critical to assess your financial situation and ensure that you can afford to wait until retirement to use your HSA funds. If you have medical expenses and don’t have any disposable income, using your HSA to pay for them is a great idea. Saving money in an HSA while neglecting your health or amassing debt will almost certainly result in increased expenses in the future. Many employers offer an HSA as part of their benefits package. As a self-employed individual, you can also access an HSA through companies such as: Lively.

However, if you have the financial flexibility to wait until retirement to touch your HSA, you may reap the financial benefits later. We can connect you to a retirement planner who can assist you in determining where you stand in your retirement savings plan and how much a fully funded HSA can help. Reach out to a RetireMentor here.

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