When it comes to tax-advantaged savings, most people focus on 401(k)s and IRAs. Often overlooked, especially by younger people, are Health Savings Accounts (HSAs). And that’s too bad. HSAs are the only type of savings account that is triple tax-free: (1) Contributions to an HSA are tax-deductible (up until age 65); (2) You can invest money within the HSA tax-free; and (3) you can withdraw money tax-free from the HSA to pay for medical expenses at any age.
It’s no wonder that some 20 million Americans now have HSAs, up from just 1 million in 2003. To make the most of HSAs, we advise this approach:
1. First, open an HSA if you qualify for one – even if you’re young and healthy. To open an HSA, you must have an insurance plan with a high annual deductible of at least $1,300 per person and $2,600 per family. The number of high-deductible policies has soared in the past decade, making HSAs an option for many.
2. Fully fund your HSA each year, if possible. Each person can transfer up to $3,400 annual into an HSA and $6,750 for a family, as of 2017. Contributions to an HSA are not counted as part of your annual taxable income. So it’s a nice upfront tax break.
3. Use your HSA as a tax-free savings vehicle, by limiting withdrawals if possible. Once you put money into an HSA, the account is yours throughout your life, even if you open the HSA account through work and then change jobs. Once in an HSA, your money grows tax-free: you can invest it stock and bond funds without having to pay capital gains or investment income taxes. The longer you leave money in your HSA invested, the more you’ will have to pay for healthcare when you’re older.
Remember that if necessary, you can make tax-free withdrawals at any age to pay for medical expenses (but not health insurance premiums), such as co-payments for doctor visits, other costs not covered by health insurance, and drugs.
4. Once you retire or hit age 65, use your HSA to pay for medical expenses. Beyond age 65, when you qualify for Medicare, your HSA contributions are no longer tax-deductible. And it is after age 65 that many people rack up large medical expenses, including for long-term care. Medicare generally pays for only about 62% of health care costs for Americans age 65 and older, and it does not cover nursing home or other types of long-term care. Furthermore, the percentage of employers who offer health benefits after retirement has plummeted.