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The Retirement Account You Never Knew You Needed and Didn't Realize You Already Have

Of all the expenses we have in retirement, there’s one that’s less predictable than the others: your medical expenses. It's easy to imagine what your housing costs, transportation, and other regular needs will be in retirement.

Yet, when it comes to your health, it’s much more uncertain. Will you be healthy for a long time? Will you need ongoing treatment for an illness? Will you have an expensive surgery? On average, the typical couple needs $300,000 in retirement for medical expenses, but that number varies greatly from person to person and depends on a variety of factors.

No matter what, it’s probable that you’ll have medical expenses when you retire. The likelihood only increases the longer you live. So, even using a conservative estimate, most of us will have considerable medical expenses when we retire.

Knowing that, we should consider how to pay for them. Outside of insurance and Medicare, most retired people pay for medical expenses from their 401(k) accounts or other savings.

But there’s a much better way. Your health savings account (HSA) is a lesser-known, more efficient way to save for medical expenses. In fact, you may have an HSA already and you may be taking it for granted. Most people believe an HSA is only for reimbursing your medical bills now.

Your HSA has far more power than that, when it comes to its capabilities and how it can help you save money.

First, a little background. You must be enrolled in a high deductible health plan (HDHP) to be eligible for an HSA. Most high deductible plans include HSAs, but make sure to double-check your plan options. Premiums are lower for high deductible plans, and consumers are responsible for paying their medical bills until they reach the maximum out-of-pocket or deductible specified by their plan. The biggest advantage of paying your medical bills from HSA dollars is the tax savings. You pay zero in taxes if you use the money for eligible expenses, like doctor and hospital visits, medical equipment, and prescriptions.

Barring the unexpected, you can start contributing to your HSA and have the money ready when you need it to reimburse your medical bills. Another benefit of HSAs is that if you do not use the money right away, don’t worry. It’s always yours to keep, even if you change employers or stop contributing for a while. If you can build up a balance over time, even better. Because that’s where the benefits of HSAs can really take off.

Saving for retirement in your HSA can be an extremely cost-effective and efficient savings vehicle. There is a potential to save even more in an HSA than a 401(k) or similar retirement plan, even when the amount going in is the same.

Three reasons to save in your HSA over your 401(k)

1. Tax advantages

The top reason to put money into your HSA is the tax advantages. You avoid paying all taxes on your HSA contributions if you use the money to pay for eligible medical expenses. That’s even better than the 401(k), where FICA tax (7.65% as of 5/14/21) still applies before your contributions are made.

Considering the FICA tax advantage, it means:

2. You’ll have more

Since there is more money going in, the balance grows faster and can compound on itself tax free over time.

3. You’ll need less

Unlike your pre-tax 401(k), you don’t owe taxes at withdrawal either, if you use the HSA money to pay qualified medical expenses.

Consider this example. You have a $1,000 medical bill in retirement.

  • With the HSA, you take $1,000 out to pay it.
  • With the 401(k), you’d need to take $1,000 plus enough extra to cover the taxes. So, if you’re in the 25% tax bracket, that would mean withdrawing $1,250.

You might be thinking, what if I have all this money in my HSA at retirement and don’t have eligible expenses? Not to worry, normal tax applies if you withdraw money from your HSA for non-eligible expenses, the same way it would from your 401(k).

One more useful thing to know. Similar to other savings accounts, you have the option to invest that money (check your plan for specific minimums needed to start investing). Most Health Savings Accounts offer cash, mutual funds, and other investment options for helping your money grow over time.

If you are like most of us, you have a set amount of money in your budget for savings. Due to the tax advantages of Health Savings Accounts over traditional retirement savings products, we encourage you to review your employer’s plan design and develop a strategy around how much to save and where to invest. With the goal to take advantage of employer contributions but consider the tax advantages of a Health Savings Account.

To learn more, watch the OneDigital Financial Academy session on Maximizing Your HSA or download our Guide to the Tax Benefits of Health Savings Accounts.

Helpful resources for employers:

When people understand how health savings accounts work, they’ll be more likely to choose your high deductible health plan. That means you could save on insurance costs right away and potentially reduce medical trends over time. Download these resources to learn more.

Investment advice is offered through OneDigital Investment Advisors LLC, an SEC-registered investment adviser and wholly owned subsidiary of OneDigital.