Here’s the best way to use a health savings account
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Health savings accounts can be a powerful way to build wealth and prepare for medical costs in old age — if they’re used the right way.
HSAs carry a three-pronged tax benefit. Contributions and investment growth are tax-free, as are withdrawals if used for qualified health expenses.
Even if a withdrawal isn’t health-related, the account owner would only owe income tax on those funds — in effect turning the HSA into an account with tax benefits akin to a traditional 401(k) plan or individual retirement account.
“I almost don’t think of them as health savings accounts, but profoundly tax-beneficial retirement accounts,” said Andy Baxley, a Chicago-based certified financial planner at The Planning Center.
Ideal use
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The ideal way for savers to use HSAs is by contributing the annual maximum, investing the money and paying for present-day health costs out of pocket via other savings, according to financial advisors.
This allows time for HSA money to grow tax-free. HSA investments are like those in any other retirement account, with diversified stock and bond mutual funds, for example.
Most people don’t invest their HSA savings, however. They instead use HSAs like a bank account and withdraw cash as needed to pay for current medical costs.
Just 9% of accountholders were investing a portion of their HSA balance in 2020, according to the Employee Benefit Research Institute. The remainder — 91% — held their full balance in cash.
But this offers virtually no upside growth — a disadvantage when health costs in retirement are expected to be about $300,000 for the average couple who retired in 2021, according to a Fidelity Investments estimate.
The IRS outlines a wide variety of qualifying HSA health costs, like those associated with dental care, vision, hearing, long-term care insurance premiums (subject to limits) and medicines, for example.
HSA reimbursement
Savers who pay out of pocket now for health costs can take advantage of another HSA benefit in future years: They can withdraw account funds to pay themselves back (tax-free) for those earlier expenses.
As with withdrawals from a Roth 401(k) or IRA, these HSA reimbursements can offer retirement income and help someone control their tax bill.
An HSA is a no-brainer for almost everyone who has access to one.
Carolyn McClanahan
founder and head of financial planning at Life Planning Partners
Say you’re on the cusp of jumping into a higher income-tax bracket in retirement but had spent $10,000 out of pocket over the years on medical bills. You can withdraw that $10,000 from your HSA for past costs without raising your taxable income.
(One important point: Expenses incurred before you establish your HSA aren’t considered qualifying medical costs.)
“I think [people] often don’t realize just how broad the list of things you can be reimbursed for is,” Baxley said, citing fertility treatment as an example.
He recommends…
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