A 2021 survey from Charles Schwab shows that only 49% of people with access to an HSA, or health savings account, are using it. That's unfortunate because the HSA could easily be the difference-maker in an effective retirement plan.
Here are three reasons why you should be contributing to your HSA and investing those contributions for long-term growth.
1. Healthcare expenses can eat up your savings
Predictions on healthcare expenses for retirees are scarier than any horror movie. Fidelity estimates that a 65-year-old woman who retires in 2021 will spend about $157,000 on out-of-pocket medical costs throughout retirement. A 65-year-old man retiring this year will spend an estimated $143,000 on healthcare. A different report from healthcare software company HealthView predicted that a 65-year-old couple retiring in 2019 would incur $387,644 in cumulative healthcare expenses during retirement.
Worse, those estimates are probably insufficient for anyone who's younger than 65. Between 2011 and 2020, healthcare inflation over the last 10 years has outpaced general inflation — at times, stretching above 4.5%.
High healthcare inflation increases your lifetime medical expenses, but it can also break your retirement distribution plan. Many retirees plan for a set withdrawal amount in retirement, with annual increases for inflation. If healthcare costs are one of your larger expenses and they're rising faster than general inflation, your planned inflation increases may be insufficient.
Fortunately, the stock market typically grows faster than healthcare costs. Investing your HSA funds gives you a chance to outpace healthcare inflation — which is essential to increasing your preparedness.
2. Your HSA has a triple tax benefit
The HSA is the only account that offers three tax benefits:
Contributions are tax-deductible. Your tax deductions lower the cost of your contributions in the current tax year.
Earnings are tax-deferred. Your HSA balance will grow faster, because you don't have to pull money out annually to pay taxes.
Withdrawals to fund qualified medical costs are tax-free. Qualified medical costs include drug costs, copayments, and co-insurance on dental, medical, and vision services. In retirement, you can also use your HSA to pay your Medicare premiums. The tax-free withdrawals essentially reduce your healthcare costs because you can use 100% of the funds. If you had to pay taxes on the withdrawal, your available cash is reduced by your tax liability.
Investing your HSA contributions in ETFs and other equity funds maximizes the account's triple tax benefit. You should earn more over time and, ultimately, have more funds available to withdraw tax-free in retirement.
3. Your HSA can back up your 401(k) or IRA
Earmarking funds for future healthcare costs protects you against the downside scenario — that you'll require expensive medications or treatments in your senior years. But what if you age in great health and keep yourself out of the doctor's office? The HSA has an answer for that situation, too.
Once you reach 65, you can take non-medical HSA withdrawals without penalty. These withdrawals will be taxed as ordinary income, just like a qualified 401(k) or IRA distribution. That means there's no way to overfund your HSA. If you are healthy as can be, you can use the money to cover your normal retirement living expenses.
Invest your HSA funds for retirement readiness
You are (hopefully) investing your 401(k) or IRA funds for long-term growth, and you can do the same with your HSA. The long-term tax advantages and versatility of the HSA are powerful — use them to move your retirement readiness to the next level.
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