Jchances are health care will end up being one of your biggest expenses in retirement, if not your biggest expense. And so it is important to save accordingly.
You have several options in this regard. You can supplement an existing IRA or 401(k) plan, or you can fund a health savings account, or HSA.
The beauty of HSAs is that they offer more tax advantages than IRAs and 401(k). With a traditional IRA or 401(k), your contributions are made on a pre-tax basis, but investment gains are ultimately taxed and withdrawals are also subject to tax. With an HSA, your contributions are made with pre-tax dollars, and earnings in your account are tax-free, along with withdrawals, provided the money is used for eligible healthcare expenses.
Recently, investment advisory firm HSA Devenir reported that HSA balances had reached $100 billion. At the same time, only 7% of HSAs had at least part of their funds invested. And that means most HSA holders are missing out on a great opportunity to get the most out of their accounts.
The best way to use an HSA
HSAs are extremely flexible in that they allow savers to access funds for short-term medical bills or to defer that money indefinitely. In this regard, they are much more flexible than flexible spending accounts, which require savers to deplete their plan balances year after year or risk losing that money.
Meanwhile, HSAs offer the same tax-free investment growth that Roth account holders can enjoy. But based on the data above, it’s clear that most users don’t treat their HSAs like a long-term savings and investment account. On the contrary, it appears that they are using their HSAs for short-term expenses, thereby losing a major tax break.
In addition, savers who do not retain HSA funds in retirement may not be able to rely on their healthcare expenses. HealthView Services recently reported that the average healthy 65-year-old couple retiring in 2021 could spend up to $662,156 on health care throughout their old age. And so, spending HSA funds rather than investing them is a decision many will likely regret.
Now, annual contribution limits for HSAs change from year to year, as does eligibility. This is because participation in the HSA is dependent on enrolling in a high-deductible health insurance plan, and the criteria for it may change, the same way annual IRA and 401(k) contribution limits may change. From one year to another.
But someone who contributes $300 a month to an HSA over 36 years and invests that money at an average annual return of 8% (which is a little below the stock market average) could end up with around 674,000 $. This covers the projection of $662,156 per couple above.
Don’t enter retirement unprepared
Health care costs have increased exponentially over the past few years, and are expected to continue to rise. Investing in an HSA and enjoying the tax-free gains is a great way to cover senior medical expenses and avoid a scenario where money is perpetually tight.
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