Are HSAs the New IRAs?
Like Flexible Spending Accounts (FSAs), Health Savings Accounts (HSAs) allow you to set aside funds to pay out-of-pocket medical expenses. HSA-qualified expenses include co-insurance, deductibles, dental and vision care, prescriptions, and many other health-related items.
Unlike FSAs, HSAs can help those in eligible high-deductible health plans1 (HDHPs) sock away triple-tax-free money for qualified medical expenses in retirement. Here’s how:
- Contributions to HSAs are tax-deductible.2
- Capital gains, dividends and interest accumulate tax-free.3
- You pay no tax on withdrawals for qualified medical expenses.
Other notable advantages of an HSA are that it’s yours to keep indefinitely (though you can no longer contribute once you’ve enrolled in Medicare or if you’re not covered by an HDHP), and any unspent money remains in your HSA until you use it. With an FSA, if you change employers you lose the account and forfeit any unspent money in your FSA at the end of your employment. Unspent money in your FSA doesn’t rollover to the new year, either—if you don’t spend the money by the end of the year, you forfeit it.
And here’s the clincher: If you use HSA funds on non-medical expenses before age 65, you pay both ordinary income tax and a 20% penalty. However, if you use HSA funds for non-medical expenses after age 65, you pay only ordinary income tax. In other words, you’d take no worse a tax hit than you would with an Individual Retirement Account (IRA).
The bottom line
Health Savings Accounts (HSAs) are a highly effective tax-advantaged strategy for medical expenses in retirement.
1 Defined as those with a minimum annual deductible of $1,400 for individuals and $2,800 for families and maximum out of pocket amounts of $7,050 for individuals and $14,100 for families. Enrollees can’t be enrolled in Medicare, claimed as a dependent on someone else’s tax return or covered by another health plan without a high deductible.
2 While HSA contributions are exempt from federal income tax, they are not exempt from state taxes in Alabama, California, New Jersey, and Wisconsin.
3 State taxes may vary.