Many people regard health savings accounts, or HSAs, as near-term savings tools. The money you put into an HSA can be withdrawn immediately to cover medical expenses, so you might assume that it's smart to fund your account minimally, take withdrawals as needed, and call it a day. But actually, HSAs can also serve as an important retirement savings tool. Here are a few reasons to fund one for your later years.
1. You'll need the money for medical expenses
Fidelity reports that the average 65-year-old couple retiring today will spend $295,000 on medical costs throughout retirement, including out-of-pocket expenses under Medicare. That figure further breaks down into $155,000 for single older females and $140,000 for men. If you're planning to live mostly on Social Security, or Social Security benefits coupled with savings, then it will help to have a dedicated source of income on hand to put toward healthcare.
2. You'll lower your tax burden in retirement
HSAs offer lots of tax benefits. Not only do contributions go in tax-free, but any money in an HSA that you don't use immediately can be invested and grown in a tax-free fashion. Furthermore, withdrawals are tax-free when they're used to pay for qualified medical expenses. And the latter could really come in handy during retirement, especially since taxes tend to catch so many seniors off-guard.
Not having additional taxable income to worry about will help keep your IRS burden to a minimum. And also, the less taxable income you have, the less likely you'll be to pay taxes on your Social Security benefits.
3. You'll have flexibility once you turn 65
Just as there are penalties for taking an early withdrawal from a 401(k) or IRA, penalties will apply if you withdraw money from an HSA for non-medical purposes. But whereas the penalty for an early 401(k) or IRA withdrawal is 10% of the sum you remove, with an HSA, it's 20% of your distribution. Not only that, but you'll be hit with a tax bill on your withdrawal.
The rules change for the better, however, once you turn 65. At that point, you're allowed to withdraw money from your HSA for any reason at all without being penalized 20%. If your withdrawal is taken for non-medical purposes, taxes will apply, but if your healthcare costs during retirement happen to come in much lower than expected, you can rest easy knowing you'll still be able to use your HSA funds.
Consider an HSA for your senior years
Though HSAs can certainly come in handy during your working years, they can be even more useful to you as a senior, when your budget may be tighter and your income more limited. Not everyone qualifies to contribute to an HSA. To participate, you must be enrolled in a high-deductible health insurance plan, the definition of which changes yearly but is currently an individual deductible of $1,400 or more or a family level deductible of $2,800 or more. You also can't fund an HSA if you're already enrolled in Medicare.
But if you do qualify to put money into one of these accounts, it pays to contribute more than what you anticipate needing in the near term. That way, you'll secure an additional source of retirement income that could come in very handy at that stage of life.