This article has been updated for 2016
Have you heard of the health savings account (HSA)? These accounts have been gaining steam as of late and there are a few reasons why. Before I get into why many people have been opening HSAs, let me explain what they are.
The HSA is a nifty little account that allows you to contribute pre-tax money into an account that is designated for health expenditures. This means that you save the equivalent of your tax rate instantly when paying for health expenses. These accounts are similar to investment accounts because they can be invested into mutual funds, bonds, and stocks. You are allowed to pull the money out of the account tax-free if it is for an eligible medical cost.
Who Can Open One?
Health savings accounts are not available for everyone. These accounts are only for individuals or families that have high-deductible insurance plans. A high-deductible plan is one that has an annual deductible of at least $1,300 for an individual and $2,600 for a family. If you meet these guidelines then you can set one up. You can open your own HSA or you can go through an employer.
Many employers offer an HSA, but they control where the money can be invested. They would handle this much like a 401(k). Make sure you don’t confuse a health savings account with a health “spending” account. These are two different accounts that don’t offer the same benefits.
How Much Can Be Contributed?
As of 2016, an individual can contribute up to $3,350 and a family can contribute up to $6,550. People 55 years and older can contribute $1,000 more in 2016. Any money left over in your account at the end of the year will be rolled over to the next year. It will continue to grow tax-deferred until you pull it out.
Much like a 401(k), if you pull it out before age 65, you will have to pay a 10% penalty along with being taxed at your regular rate. As noted before, you can pull the money out at any time for qualified medical expenses, no matter the age.
After someone turns 65, they can then pull money out of the account for non-medical related expenditures. They will be taxed just like a traditional IRA, but there will be no penalty fee.
HSA As A Retirement Account
The main reason why so many people are opening HSAs is that you can use them just like a traditional IRA. Whatever money you contribute, but don’t pull out for medical expenses can be rolled over year after year. Combining a HSA account along with another IRA account can allow you to tax-defer some of your income. The biggest benefit comes when you max out your IRA and your HSA. You can then pull as much as the government allows pre-tax and have it benefit you in the future.
If you want to treat the HSA just like another retirement account, then don’t touch it and pay for your medical expenses with money you already have. If you can’t afford all of the expenses, then tap into the HSA. The money only grows if you don’t use it, but it is still there as a safety net for medical expenses.
Readers: How do you plan on paying for health care costs during retirement?