Health Savings Accounts (HSAs) are a great way to pay for medical expenses, and since unused funds roll over from year to year, the account can also provide a source of retirement funds in addition to other plans like 401(k)s or IRAs. But be aware of how HSAs compare to other retirement investment tools.
HSAs work best when they are used to pay for qualified medical expenses. Neither your original contributions to an HSA nor your investment earnings are taxed when used this way. There is no required minimum distribution after you reach age 70½, like there is with 401(k)s and IRAs. You can only contribute to an HSA if you have a high deductible health insurance plan.
The downside of these plans is that you pay more out of pocket each year when you need to use health services. Annual contributions to HSAs are limited to $3,400 a year for individuals and $6,750 a year for families (add $1,000 for people aged 55 or older). HSAs typically have fewer investment options compared with other investment tools including 401(k)s and IRAs. They also often have high management and administrative fees.
Before you reach age 65, non-medical withdrawals from HSAs come with a whopping 20 percent penalty, plus they are taxed as income. Even after age 65, both contributions and earnings are taxed when they are withdrawn for non-medical expenses. In this way, HSAs compare unfavorably with 401(k)s and IRAs, which end their early withdrawal period earlier, at age 59½. They also have lower early withdrawal penalties of just 10 percent.
HSAs are a powerful tool to help manage the ever-rising costs of health care. Knowing the rules and the costs associated with them can help you position an HSA with your other retirement options.