Your HSA: A Powerful Retirement Savings Vehicle?

I was talking with a friend recently about Health Savings Accounts (HSAs). He had just become eligible to contribute through his employer and wasn’t sure whether it was a smart move. Many people have similar questions: How does an HSA work? Is it worth the effort? I explained that an HSA can be one of the most powerful retirement savings vehicles available because of the tax advantages it offers.

Understanding how an HSA fits into your retirement planning is key. This article explains what an HSA is, who qualifies, common pitfalls, and how to use it in the most tax-advantaged way.

What is a Health Savings Account?

A Health Savings Account (HSA) is an account that you open with a bank, insurance company, or other approved financial institution to help pay or reimburse certain medical expenses you incur. The contributions into the account can be completed through payroll deduction or as a lump sum. In addition, some employers offer an annual contribution into your HSA as an employer benefit.

What are the benefits of a Health Savings Account?

According to IRS Publication 969, the benefits include:

• Contributions you make (or those made by someone other than your employer) are tax-deductible, even if you don’t itemize deductions.

• Employer contributions (including through a cafeteria plan) may be excluded from gross income.

• Funds remain in your account until you use them.

• Interest or other earnings grow tax-free.

• Distributions for qualified medical expenses are tax-free.

• HSAs are portable; the account stays with you if you change employers or leave the workforce.

Who qualifies to make Health Savings Account contributions?

To contribute to an HSA, you must meet these requirements:

• You are covered under a high-deductible health plan (HDHP) on the first day of the month.

• You have no other disqualifying health coverage. You may still qualify if your spouse has a non-HDHP, as long as you aren’t covered under that plan.

• You aren’t enrolled in Medicare.

• You cannot be claimed as a dependent on someone else’s tax return.

What are the common pitfalls?

1. Using your HSA Account for Non-Qualified Medical Expenses

   IRS Publication 969 provides a full list of qualified medical expenses. Common non-qualified expenses include over-the-counter medications without a prescription and most insurance premiums. Exceptions include long-term care insurance premiums, COBRA premiums, coverage while receiving unemployment, and Medicare premiums if over age 65.

2. Separate HSA Accounts vs. Joint Accounts

   When both spouses are eligible to contribute to an HSA, each must have a separate account; joint accounts are not permitted.

3. Assuming Your High Deductible Health Plan is HSA-qualified

   Not all high-deductible health plans qualify for HSA contributions. IRS rules require minimum and maximum deductibles, and some plan benefits may disqualify the account. Always confirm with your HR department or insurance provider before enrolling.

4. Medicare Coverage and HSAs

   Once you enroll in Medicare (including Part A), you can no longer make HSA contributions. This is a common area of confusion, so check with your Medicare agent before enrolling if you still have employer coverage.

How to use your Health Savings Account if you can’t afford to maximize your contributions each year

If you cannot maximize contributions each year, use your HSA to pay qualified medical expenses as they arise. For example, contribute the amount of a medical bill to your HSA first, then pay the bill from the account. This provides a tax deduction on the contribution.

HSAs can be a powerful retirement savings vehicle for those who can maximize contributions and pay current medical expenses from other funds. Contributions are tax-deductible, growth is tax-deferred, and distributions are tax-free for qualified medical expenses.

For more information, see IRS Publication 969 or schedule a call to see whether an HSA strategy fits into your retirement plan.