When it comes to retirement planning, 401(k) plans and IRAs, whether Traditional or Roth, are usually the go-to option for tax-savvy investors. However, some planners note that there’s another choice with even bigger tax breaks: a health savings account (HSA).

It’s easy to dismiss HSAs as simply a niche savings vehicle because they’re designed with medical expenses in mind. What’s more, you need to carry a high-deductible insurance plan in order to use them. Perhaps that’s why relatively few Americans have done so. According to an Employee Benefit Research Institute report from last year, an estimated 20 to 22 million Americans owned an HSA, and the average account had a modest $1,844 balance.

A piece of paper on a clipboard with the words HSA on the top.

The Advantages of an HSA

Should HSAs have a bigger place in your retirement strategizing? Consider this: Health savings accounts are unique in offering a triple tax advantage, something that not even a 401(k) and other workplace plans can claim. Savers invest with tax-deductible contributions and watch the money grow tax free.

Unlike with a traditional 401(k) and traditional IRA, workers can then withdraw the money without incurring taxes, so long as it’s used for qualified medical expenses. Those include everything from contact lenses and smoking-cessation programs to lab tests and operations.

What’s more, some HSA providers let you invest your money in mutual funds and index funds, rather than having them sit in an FDIC-insured savings account that pays a skimpy interest rate. That’s certainly an advantage for younger workers, who can withstand short-term market fluctuations and could benefit from investment growth over the long haul.

This year individuals can contribute up to $3,400 a year toward their accounts, and families can kick in up to $6,750. Those who are age 55 or older can use a special catch-up provision that allows them to invest an additional $1,000.

HSA or 401(k)?

You may be wondering why you’d want to put large sums into an HSA, given its limited use. Remember, you have to use the funds for qualified medical outlays in order to get their full tax benefit.

The fact is, however, that healthcare represents a huge part of the typical American’s retirement budget. According to Fidelity Benefits Consulting, the average 65-year-old couple will spend $275,000 (in today’s dollars) on medical expenses. So chances are you’ll end up needing a lot more than the typical person has socked away in an HSA.

It’s also important to realize that you can avoid the usual 20 percent penalty on withdrawals that go toward nonmedical expenses once you reach the age of 65. You’ll have to pay income taxes, of course, but even then you’re essentially getting the same break as a traditional 401(k), where the only tax hit comes on the back end. So building up a large balance over time isn’t exactly a risky proposition from a tax standpoint.

As a general rule you’ll want to max out your employer’s match on a 401(k) before turning your HSA into a de facto retirement plan. Nevertheless, there are exceptions. For example, some experts suggest that because of the triple tax advantage those with little or no company match might want to hit their HSA caps before turning to their workplace plan.

After all, people in the 25 percent tax bracket save one-quarter of their balance by avoiding the tax on withdrawals, so long as they use the money for healthcare needs. It’s an advantage that’s hard to ignore.

At the very least you can use your HSA to complement your other tax-advantaged retirement vehicles. For example, single tax filers can put $18,000 into a 401(k) and another $5,500 into a Roth IRA (not counting catch-up contributions for those 50 years of age and over). Once those are maxed out, single filers can take advantage of the additional $3,400 limit that HSAs allow.

Selecting a Health Plan

There is one caveat to all this: High-deductible health plans aren’t available—nor are they a great fit—for every American. Some individuals may not have them as an option on their state’s exchange, or your employer may not offer one as part of its benefits package.

Even if the option is on the table, it’s worth considering the pros and cons. You’ll find yourself paying smaller premiums, but your deductible and total out-of-pocket expenses could be substantially higher with these plans.

Furthermore, those who are in a lower tax bracket won’t get the same benefit from the accompanying HSA that a higher-income earner would. Make sure that you carefully consider the implications of an unforeseen medical crisis, as well as the tax consequences, before you go with a more bare-bones health insurance plan.



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