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How a Health Savings Account Can Fatten Your Nest Egg

Used smartly, this tax-free tool won’t just pay for medical bills—it can supplement your retirement.

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by Jean Chatzky

Well-Being
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If you’re among the millions of Americans with a high-deductible health insurance plan, having a government subsidized health savings account (HSA) can save you tens, even hundreds of thousands of dollars in health care costs over your lifetime. “An HSA can save you an average of 25 percent on your health care expenses—sometimes more—depending on your tax bracket,” says Deborah Culhane, senior vice president of Optum, a health services company that empowers consumers to take control of their own wellness.

But just having a health savings account isn’t enough. What’s key is making the most of the advantages HSAs offer to help secure your financial future. Unfortunately, many people aren’t. Why? Lack of knowledge: HSAs didn’t really catch on until the last few years. That’s why Culhane says it’s important that industry leaders step up to “educate and empower consumers.”

An HSA can save you an average of 25 percent on your health care expenses—sometimes more—depending on your tax bracket.  -Deborah Culhane, Senior Vice President of Optum

The good news is that HSAs aren’t all that complicated. An HSA is a tax-advantaged savings account you can open at just about any bank or brokerage firm and fund to pay your health care expenses. To qualify, you need a health insurance policy with a deductible of at least $1,300 (for singles) or $2,600 (families). All silver and bronze Obamacare policies qualify. You can contribute up to $3,350 (singles) or $6,750 (families) per year to your account (some employers supplement this contribution) and use that money to pay for deductibles, copays, coinsurance and other “qualified health care expenses” that your health insurance doesn’t cover.(Among the uses you might not think about: health insurance premiums—including COBRA premiums—long-term care insurance premiums and acupuncture. The IRS has a 40-page list.) 

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As for those tax advantages: In industry lingo, HSAs are triple tax-free. Money you contribute is tax deductible, and any money your employer contributes isn’t subject to payroll taxes. Once in the account, money grows tax-free. And as long as you use the money for qualified health care, you won’t pay taxes on it when you pull it out. On the flip side, any money you withdraw before age 65 to pay for non-medical expenses is subject to a 20 percent penalty and ordinary income taxes. But after age 65, if you use the money for non-medical expenses you’ll be taxed but not penalized, just as you would on withdrawals from a 401(k).

Another plus: There’s no “use it or lose it” rule if you don’t spend it in the year you contribute it, as you would with a flexible spending account (FSA), with which HSAs are often confused. It’s yours forever. (Also, unlike an FSA, you can add to your HSA throughout the year.) If you change jobs or retire, your HSA goes with you. The same is true if you decide you no longer want a high deductible health plan. You can switch insurance and your account will continue to exist. You will still be able to invest and use the money in it (more on that below); you just won’t be able to make contributions.

Make the most of the advantages HSAs offer to help secure your financial future. If you’re like most folks, you are leaving a lot of those benefits on the table.

Now that you know the basics, here are the five questions you need to ask to get the most out of this versatile tool: 

1. Where should I open an HSA? That depends how you’re going to use it.Costs and features vary. Some HSAs charge annual fees, others monthly fees, still others only charge fees if you don’t maintain a particular minimum. You can compare providers at HSAsearch.com. Next, look at how the account enables you to pay for healthcare; it’s easiest if the HSA gives you a debit card, with an online banking option to monitor your account. Finally, if you’re planning to use the account as a supplemental retirement account—and let the money grow over the long haul—you’ll want the ability to invest in stocks or mutual funds rather than just earn savings-account interest rates.

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Of the 240 providers at HSAsearch.com, the majority offer no investment options (but instead pay interest on deposits.) Some offer only CDs or mutual funds, while others allow you to buy stocks and bonds. Typically, consumers have to amass a minimum balance before investing. For example, at SelectAccount and The HSA Authority, investors need to hit a $1,000 threshold; at Optum Bank and Fifth Third Bank it’s $2,000. (All four are among the top five user-rated providers at HSAsearch.com; the other provider in the top five, Kitson Bank, doesn’t offer investment options.)

2. What’s the best way to spend HSA funds? The smartest strategy may be to not spend these funds—at least not immediately. Instead, if you can swing it, let the money grow, while paying for health care needs out of taxable income. That way you’ll accumulate a health care nest egg for when you really need it. Fidelity Investments estimates that a 65-year-old couple with an average life expectancy will spend $240,000 in retirement on unreimbursed health care needs. If you’ve saved that money in your HSA, you can pay with money that isn’t taxed. That’s not true of money coming out of your 401(k).

But even if you don’t think you’ll take advantage of your HSA, you should still open the account as soon as you purchase a qualifying health plan, even if you only put $1 in it, says Stephen D. Neeleman, M.D., author of The Complete HSA Guidebook. Then, if you have a medical expense, you can put the money into the account you’ve already opened, use it immediately to pay your bill and come tax time, deduct that money from your adjusted gross income and lower your tax bill. 

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3. How aggressively should I invest the money in my HSA? That depends on how you plan to use these funds. The closer you are to any goal, the less risk you want to take with that money. So, if you’re counting on your HSA money to pay for health care needs within the next three years, you shouldn’t put the money at risk. Put it in a savings or money market account or CDs.

However, if you’re planning to pay for health care with funds outside your HSA in order to grow the money in your account for retirement, you’ll want to invest it as you would the money in your 401(k) or IRA. Not many people are doing that right now, says Paul Fronstin, director of health research and education for the Employee Benefits Research Institute. EBRI has a database of 3 million HSAs; only 6 percent of those account holders are investing rather than saving their funds. 

4. I already have a 401(k) and a 529 college savings account. Which do I fund first?  The best thing you can do is grab any free money, in the form of an employer match or incentive. So, look at the dollar-for-dollar payoff. Some employers give you HSA money for simply choosing the high-deductible health plan. Others will match a certain percentage or amount of money that you contribute to your own HSA. Still others offer incentives for participating in programs designed to lower your health expenses: completing a health-risk assessment, taking stress or weight-management classes or undergoing biometric testing.

Compare all of those benefits with the contribution you have to make in order to tap 401(k) matching dollars. Grab any available free, employer-provided HSA dollars first, as described above, then employer-matching dollars. After that, Neeleman suggests topping off your HSA (again, because the money is tax-free going in as well as coming out) before maxing out your 401(k). Finally, if your HSA and 401(k) are topped off, you can move onto other tax-advantaged options, like 529 college savings accounts, which sometimes offer a state income tax deduction.

5. Anything else I should do? Yes, make catch-up contributions if you can afford it. HSAs allow individuals 55 and over to contribute an extra $1,000 annually. One note: Until you hit age 55, it doesn’t make sense for spouses to maintain separate HSAs. But once you’re there, you each need an account in your own name so each can contribute the extra grand. And keep your eye out for all your preventative benefits. HSA-eligible plans, under Obamacare, are all required to provide a certain level of paid-for preventative care (i.e., you don’t have to dig into your deductible). Experts say people who have these plans are taking advantage of this feature. That’s yet more evidence that signing up for an HSA-eligible health care plan and opening a health savings account can be good for both your health and your wealth.