Are HSAs the New IRAs?

Like Flexible Spending Accounts (FSAs), Health Savings Accounts (HSAs) allow you to set aside funds to pay out-of-pocket medical expenses. HSA-qualified expenses include co-insurance, deductibles, dental and vision care, prescriptions and many other items not covered by Medicare.

Unlike FSAs, HSAs can help those in high-deductible health plans¹ (HDHPs) sock away triple-tax-free money for qualified medical expenses in retirement. Here’s how:

• Contributions to HSAs are tax-deductible.²
• Capital gains, dividends and interest accumulate tax-free.³
• You pay no tax on withdrawals for qualified medical expenses.
   

Other notable advantages of an HSA is that it’s yours to keep indefinitely (though you can no longer contribute once you’ve enrolled in Medicare or if you’re not covered by an HDHP), and any unspent money remains in your HSA until you use it; whereas, you’ll lose your FSA if you change employers and you must forfeit any unspent money in your FSA at the end of the year.

And here’s the clincher: If you use HSA funds on nonmedical expenses before age 65, you pay both ordinary income tax and a 20% penalty; however, if you use HSA funds for nonmedical expenses after age 65, you pay only ordinary income tax. In other words, you’d take no worse a tax hit than you would with an Individual Retirement Account (IRA).

The bottom line: Health Savings Accounts (HSAs) are a highly effective tax-advantaged strategy for medical expenses in retirement.

¹ Defined as those with a minimum annual deductible of $1,400 for individuals and $2,800 for families. Enrollees can’t be enrolled in Medicare, claimed as a dependent on someone else’s tax return or covered by another health plan without a high deductible.
² While HSA contributions are exempt from federal income tax, they are not exempt from state taxes in Alabama, California, New Jersey and Wisconsin.
³ State taxes may vary.