Alongside the well-established 401(k), individual retirement accounts (IRAs) help form the backbone of modern retirement planning. When you look at their favorable tax treatment, it’s not hard to see why they enjoy such popularity.
Unlike other investment accounts, contributions to Traditional IRAs can be deducted from your income taxes, allowing you to put away a bigger share of your paycheck. Plus, investors benefit from tax-deferred growth until they withdraw the money in retirement.
But is it possible that there’s an even better option for workers who have already met their company’s 401(k) match. In a number of respects, health savings accounts (HSAs) are a compelling alternative.
Health Savings Account Details
With HSAs, you can contribute pre-tax dollars and take advantage of tax-deferred growth, just as you would with a Traditional IRA. But on top of that, you don’t pay income tax on funds that you withdraw for qualified medical expenses. Finance gurus call it the “triple tax advantage.”
What’s more, you don’t have to take required minimum distributions, or RMDs, once you reach 70½ years of age, as you would with a Traditional IRA.
In 2017, individuals can contribute $3,400 a year toward a health savings account, and families can commit up to $6,750. Those numbers will go up slightly in 2018, with the IRS setting limits of $3,450 and $6,900, respectively.
So why haven’t HSAs taken off as an investment tool? The fact is, most Americans think of them as a short-term savings option, not a method of putting away money for retirement. What’s more, in order to have one, individuals or families need to have a high-deductible health plan (HDHP), not the best insurance choice for everyone.
According to a 2016 Employee Benefits Research Institute report, fewer than 22 million Americans own an HSA. And those who have one carry an average balance of just $1,844.
It’s easy to see why the HSA gets pigeonholed as a way to pay off current needs like doctor bills, lab fees and eyeglasses. If you use the money for anything other than a qualified medical expense, you’ll get slapped with a steep 20 percent penalty.
But the reality for most people is that medical expenses will represent a big part of their budget in retirement. A report by Fidelity Benefits Consulting, for example, found that the average 65-year-old couple will spend $275,000 on healthcare costs over the rest of their lives—and that’s $15,000 more than the 2016 estimate.
If you’re remarkably healthy as you get older, you can withdraw funds after age 65 for nonmedical expenditures, too. Yes, you’ll have to pay income tax on the money you pull out for other needs, but in that sense you’re no worse off than when you withdraw funds from a Traditional IRA.
Choosing a Provider
The fact that many HSAs bear the hallmarks of savings and checking accounts—earning their users tiny interest payments—helps fuel the perception that they’re best for short-term needs.
However, a number of providers offer a range of investment options, including mutual funds and index funds, that enable you to benefit from long-term market growth. Are they going to offer the investment flexibility that an IRA does? No. But for folks who like simplicity and immediate diversification, HSAs represent a compelling choice.
To find the right health savings account, be prepared to do a little research. Look for the kinds of investment options various providers offer (if any), what their funds charge in management fees and whether there are any additional account maintenance fees. Keep in mind that you might be better off paying a small monthly fee if it means access to low-cost funds that meet your needs.
If you’re short on time, Morningstar’s annual assessment of plan providers is a nifty tool. Its most recent report favors Bank of America, HealthEquity, Optum and The HSA Authority among banks geared toward investors, based on their fund choices and favorable expense ratios.
Don’t feel like you’re stuck with the plain-Jane HSA that your employer offers, either. You can always set up a separate account with a provider you like and periodically transfer money from your workplace HSA. But a word of caution: Be sure to leave enough money your employer HSA to avoid any low-balance penalties.
If you do qualify to have an HSA, it offers a more flexible way to save for retirement than a Traditional IRA. You just have to be willing to have a HDHP—a choice that works best for very healthy people and those affluent enough to self-insure until they meet the deductible. If that’s you, you’ll benefit from the lower monthly cost of this type of insurance as well as the savings and earnings potential.