How to use the HSA, for medical or retirement savings

Health savings accounts offer a unique triple tax advantage.

  • By Julia Carpenter,
  • The Wall Street Journal
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The health savings account, or HSA, can be a powerful savings tool—if you approach it the right way.

These accounts, which Congress authorized in 2003, are more than just a simple savings tool for medical emergencies. Retirement planners laud the HSA’s triple tax advantage and its use as a complementary savings vehicle to 401(k) plans.

How to use your HSA in retirement

Here's how retirees can apply health savings account to their medical expenses.

Oftentimes when people first hear of HSAs, it is during this time of year. For companies with policies that start in January, open enrollment typically happens in the fall. During this period, many employees are already stressed about choosing and selecting other benefits.

“I don’t think most people understand HSAs from the get-go,” said Roy Ramthun, a consultant who specializes in HSAs. “From my experience, the HSA gets 30 seconds of the health benefit presentation. It’s all about the insurance, and then ‘Oh, you have this.’”

HSAs are unique in the triple tax advantage they offer: If you opt for a high deductible health plan, you can contribute to an HSA by setting aside pretax earnings without paying federal or state income tax. From there, that money can be invested and grows tax-free. Additionally, if used for medical expenses, this money can be withdrawn tax-free before retirement, which can’t be done with a 401(k) or an individual retirement account.

Eric Remjeske, president of Devenir Group LLC, said since Congress authorized these accounts in 2003, the number of accounts and the average account balance have both grown over time. By 2011, there were 6.2 million HSAs, according to Devenir Research; this past June, that number had grown to 26.3 million.

More money is flowing into HSAs every year. Devenir Research data show that $43.5 billion was deposited in HSAs in 2018, with $10.2 billion invested, a sharp increase from the year before when $31.5 billion was deposited and $5.5 billion invested. By 2021, Devenir estimates that number will rise to $67 billion deposited with $21.2 billion invested.

While the 401(k) remains the predominant retirement savings vehicle, Mr. Ramthun recommends contributing to both a 401(k) and HSA, especially if your employer offers a match for either. “Advisers are now asking the question: Where do you put the money, 401(k) or HSA?” said Steve Christenson, executive vice president at Ascensus, a retirement and college savings service provider. “They’re seeing more of a balance amongst consumers.”

To make the most of both, research if your employer offers matches. If your employer also offers an HSA match, Mr. Ramthun recommends prioritizing that contribution, as you’ll eventually be able to reap greater benefits from the HSA’s triple tax advantages. From there, contribute to your 401(k), and if your employer also offers a match there and you’re taking advantage of it, you’ll be benefiting from both savings plans.

The HSA contribution limits for 2020 are $3,550 for an individual with a high deductible health plan and $7,100 for an individual with family coverage. The catch-up contribution amount for those 55 years old or above is an additional $1,000. The amount contributed to an HSA doesn’t affect the contribution limits for 401(k) plans or IRAs, which are $19,500 and $6,000 respectively for 2020.

One approach to the HSA is to consider paying for current medical expenses out-of-pocket after establishing the HSA; you can then file for reimbursement in retirement. This way, you can supplement your retirement income—entirely tax-free.

If you’re taking this approach, you should make sure you invest your HSA balance in a diversified portfolio, so you can maximize its potential return. According to 2019 data from Ascensus, less than a third of HSA account holders eligible to invest their funds actually did so.

Meanwhile, keep track of the medical expenses you pay out of pocket. Keeping these receipts on hand means you can then file during retirement to have them reimbursed. But remember: You have to keep the receipts from any medical expenses you paid for out-of-pocket before retirement, just in case the IRS ever comes knocking for an audit.

An HSA can also be considered as a “rainy day” medical fund that works in tandem with your 401(k) to help offset the cost of out-of-network care, over-the-counter medicines or other things your insurance may not cover. Even if you’re healthy now, studies show you could still be spending much more on medical expenses once you enter retirement.

Remember: You can’t keep contributing to your HSA once you’re enrolled in Medicare. So maximizing contributions now will allow the miracle of compounding to work, growing that money in your HSA over time.

“Everything about retirement planning says, ‘Start young, be regular and invest,’” Mr. Ramthun said. “That’s what we want people to hear about HSAs.”

Storing your receipts

Saving receipts for current medical expenses can be a key part of your HSA savings strategy. To stay organized and track expenses in case of a future IRS audit, you can explore a variety of tools and plans to store these valuable materials:

  • Digitize me: You can store these receipts the old-fashioned way—in a shoebox—or the new-fashioned way via an electronic tracking system of your own choosing.
  • Some HSA providers offer online storage so you can catalog receipts online. If you’re used to keeping paper receipts, try a scanning app on your phone, like CamScanner or Scanbot. These apps allow you to take a photo of the receipt and “scan” it on your phone, which then sends the PDF upload directly to the cloud.
  • Back it up: But keep in mind if you change benefits providers that your stored receipts could be hard to transfer or reclaim. Take extra care to back those digital copies up somewhere else or, as Mr. Christenson recommends, hold on to hard copies and keep notes about how and when those expenses were handled. Make sure you tell any beneficiaries where you keep this information, too. Your spouse, if listed as a beneficiary, can inherit your HSA tax-free.
  • Understand what is an HSA-qualified expense and what isn’t: Rather than simply tagging some receipts and tossing others, understanding what qualifies and what doesn’t can simplify your record-keeping. Even dental and vision care are considered qualified HSA expenses, so keep track of these statements.
  • Be consistent: Whatever storing method you choose—whether old-fashioned shoebox or new-fashioned cloud—stay consistent, Mr. Ramthun said, to avoid being spread out over different organizing systems and risk losing important documents along the way.
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