Late starters to retirement planning have to do things differently to “catch-up.” Hacking your Health Savings Account (HSA) is one way to do just that.
The basics: Here’s how it works:
First, pair your high-deductible medical plan with a special account called a Health Savings Account (HSA.) This savings account is intended for you to have money set aside for deductibles and co-payments.
An HSA has triple tax benefits.
1. The funds come out of your paycheck on a pre-tax basis.
This gives you a tax break on the front end. For example, if you are in a 25% tax bracket and save $100 in your HSA, it would only cost you $75 out of your paycheck.
2. The funds grow tax-deferred.
You aren’t taxed on the interest the account earns since the funds grow tax-deferred in the HSA.
3. The withdrawals are tax-free.
When you use the funds for qualified medical expenses, withdrawals from the account tax-free.
Did you catch that? There is a tax break going in — pre-tax benefit, a tax break on the earnings — tax-deferred, and a tax break at withdrawal — tax-free for qualified medical expenses. I think the government wants us to use an HSA don’t you?
Related post – Can I Use My HSA For Botox Treatments?
How can you turn your Health Savings Account into a retirement account?
There is a special provision in the HSA where you can let the funds accumulate. You don’t have to spend them. Your HSA funds can then be invested in an investment account with options similar to your 401(k).
If you are concerned about running out of money in retirement, hack your HSA.
Pay your medical bills out of your paycheck now while you are working. Invest in your HSA and let it grow for retirement!
Wouldn’t it be great to have $25K or $30K in an account just for medical expenses in retirement? Oh, and the funds would be tax-free.
What if I use the money for other reasons? Is there a penalty?
If on the odd chance you don’t have ANY medical expenses in retirement, you can withdraw the money and pay income taxes. There is no penalty for withdrawal after the age of 65 but tax-wise it will act like a traditional IRA or 401(k). You’ll be taxed on what you take out (if it’s not used for medical expenses.)
Withdrawals before the age of 65 that aren’t for qualified medical expenses would have a 20% penalty and the earnings would be taxable.
What’s the catch?
There are limits to your contributions. The IRS limits contributions for an individual to $3,500 per year (in 2019.) Families can contribute $7,000 per year. If you are 55 or over, you can contribute an additional $1,000 per year.
To hack your HSA to save for retirement, gut it out.
Use your paycheck for any medical expenses you have now. In retirement, you won’t have the steady paycheck to pay the expenses. Instead, you’ll have the HSA.
Won’t this give you more confidence in your retirement plan knowing you have squirreled away thousands of dollars you will need later on?
If you are the rare person who has no medical expenses in retirement, no harm no foul. You can use the funds to pay for Medicare premiums. Take a Mediterranean cruise with the rest. Just pay taxes on the withdrawal (as travel is not a “qualified” withdrawal) and call it good.
Trust me. You aren’t going to complain that you have “too much money” to spend in retirement!