Choosing a high deductible health plan did more than give me higher deductibles (in exchange for lower premiums). It also made me eligible for a health savings account.
A health savings account (HSA) is a tax-advantaged savings account whose primary use is paying for medical expenses.
The tax advantages add up to something very special:
- On the front end: You can contribute money you earn before paying income tax on it
- As the account grows: You don’t have to pay taxes on the capital gains
- And when you spend on qualified medical expenses (As defined in IRS publication 502): You don’t have to pay taxes on the back end. Distributions not used for qualified medical expenses are taxed like income and are hit with an additional 20 percent penalty tax (So don’t do this)
In other words, if you spend money from the account in the right way, you never have to pay taxes on it.
Because funds in my 401(k), IRA, and other retirement vehicles can be taxed at some point, the HSA has quickly become my favorite way to save money for retirement.
More than just a medical account
There’s a big blind spot in what I’ve written so far. An HSA wouldn’t be a very effective retirement account if I couldn’t access the funds while in retirement.
Would the good fortune of entering retirement without a chronic health condition, bring with it the one dark cloud of not being able to spend money from my HSA?
Definitely not. According to IRS Publication 969, distributions not spent on qualified medical expenses are not subject to the 20 percent penalty if made after you reach 65 (or are disabled or die).
In other words, at worst the HSA is just as good as an IRA or 401(k). At best, they’re the best tax-free retirement vehicle out there.