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Health Savings Accounts – A New Option for Retirement?

The popularity of HSAs has started some people thinking they should use these funds for retirement. Find out why...
Friday, 04 October 2013

hsa investmentAs healthcare costs rise, many insurance providers have started offering flexible plans to meet every budget. Instead of limiting members to a choice between PPO, HMO and Short-Term health coverage, they started offering high-deductible health plans (HDHPs.) While these plans certainly addressed the hefty monthly premiums, they made it difficult for members to reap the benefits without paying thousands of dollars out-of-pocket. Enter the "Health Savings Account," otherwise known as the HSA.

The difference between FSAs and HSAs

Health savings accounts are often confused with FSAs, or Flexible Spending Accounts, most likely because both accounts draw pre-tax earnings out of an employee's paycheck, and both can be used for non-covered medical expenses. While each plan has its own "reimbursable" restrictions, they both allow members to lower taxable income and plan ahead for qualified expenses. However, some differences apply. For example, FSAs allow for dependent care expenses such as child care, as well as many more over-the-counter medications, but the funds must be spent within a single calendar year. On the other hand, HSAs allow users to accumulate funds over years, and ultimately invest them wisely.

Why HSAs, and why now?

The popularity of HSAs has started some people thinking they should use these funds for retirement. They both use money from pretax earnings, both are restricted for withdraw until the member reaches retirement age, but the HSA funds are available to pay for high deductible health-related expenses. Another restriction is that most HSA plans limit members to a definite amount of pretax contributions each year.

Personal finance writers seem confident in recommending HSAs as a retirement account, but it shouldn't be the only way to save. While they were designed to pay for healthcare in high-deductible plans, the triple-tax advantage offered by HSAs has morphed them into something more.

Here are the highlights of HSAs:

  • Account contributions are pre-tax or tax-deductible.  All earnings, interest and investment returns are tax-free.
  • Any withdrawals for qualified medical expenses are tax-free.
  • Once you reach age 65, all nonmedical withdrawals are taxed at your current tax rate, just like a traditional IRA. (If you withdraw money for nonmedical expenses before you're 65, then there's a 20% penalty.)

Investment returns?

The beauty of an HSA is how the investment isn't limited to cash. In other words, you can put your money into an FDIC insured savings account with a richly varied menu of investments to choose from. This way the HSA plan funds can be devoted to small-cap stocks, index funds, even "strategic equity."

Investment returns? Indeed. It turns out that HSAs aren't limited to cash. You certainly can put your money (restricted to $3,250 for an individual or $6,450 per family per year, plus an extra $1,000 a year if you are over 55) into an FDIC-insured savings account. State Farm offers such a product through State Farm Bank. But many companies offer a richly varied menu to suit any risk appetite: a company called Health Savings Administrators, for instance, gives you a list of of no fewer than 22 Vanguard funds to choose from, including funds devoted to small-cap stocks and "strategic equity".

When does an HSA become an "investment account?"

When you open an HSA at a major bank, you will put Wells Fargo, your money will be invested into an FDIC-insured deposit account. However, once you have $2,000 in that deposit account, you will have the option to start investing part of it in a separate, non-insured investment account. This is an attractive option for anyone with a high-deductible insurance plan, but it especially attractive for young and healthy people who rarely visit the doctor.

Who owns the HSA?

Unlike flexible spending accounts, HSAs are not owned by your employer, nor are they owned by your insurance company. This means you can open one and keep it until you retire. In fact, HSAs are listed as "retirement accounts" under federal regulations.

Is having an HSA catching on?

As of February 2013, more than 15 million people in the United States were eligible to open an HSA, up from 3.2 million just seven years ago. Higher health insurance costs have caused more people to seek out "account-based health plans" (ABHPs) with predictable out-of-pocket limits. Surprisingly, when compared with PPOs and HMOs, high-deductible plans with HSAs can provide better coverage for serious illnesses. They will also become an important strategy for people who want to avoid paying the 2018 excise tax proposed by the Affordable Care Act, which will affect many high-value insurance plans.

In addition to allowing consumers to stash more money away for retirement, HSAs are a more affordable option for individuals who are willing to pay higher deductibles. The premiums are lower than other health plans and your money has a chance to grow as a long-term investment. Furthermore, proponents argue, as consumers pay for more of their medical expenses prices will become more competitive.

Photo courtesy of Stuart Miles / FreeDigitalPhotos.net

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