By now, many of you in the United States have heard of the Health Savings Account (HSA). There are a number of benefits to contributing to an HSA — one of these is that they can effectively be treated like an extension of an Individual Retirement Account (IRA).
An HSA is a tax-exempt account held with a trustee who’s been approved by the IRS — usually a bank — which you can contribute to if you choose a high deductible health plan (HDHP). You don’t pay taxes on the money you contribute to an HSA; that is, every dollar you contribute is a dollar that you can deduct from your income for tax purposes — even if you don’t itemize your deductions. What’s more, if you do choose an HDHP, your employer might contribute money to your HSA and that money is also not included in your gross income. On the other end, distributions from an HSA aren’t taxed if you use them for qualifying medical expenses, meaning that it grows tax free.
An IRA is a retirement account where contributions may be tax deductible, and distributions are treated as income and thus subject to tax.
Why an HSA can act like an IRA
I understand the concern with mentally co-mingling account types that the IRS set up for different purposes.
Really the only thing I can say about that is that money is fungible. If you were to put a dollar each into two envelopes labeled “Health care” and “General retirement money,” I’m pretty sure your future doctor would happily accept money from either for your future health care.
The same goes for an HSA and an IRA.
This would be true in almost all cases, because you’re almost certainly going to be spending a healthy chunk of change on health care in retirement. What makes it absolutely true in all cases is that any money you take out of an HSA after you reach age 65 for ANY REASON other than health expenses is no longer subject to the penalty — just taxes. In other words, it acts EXACTLY like an IRA at that point.
The additional bonus is that you can also pull it out for medical expenses before age 65 without any penalty or taxes; which is not the case with an IRA.
That said, the ideal situation would be one in which you put loads of money in as a healthy young person, don’t use it (i.e. don’t get sick ever), and then let it compound tax-free until retirement.
So then what’s the shortcoming to HSAs? In other words, why not make this your main retirement vehicle?
As of the 2014 tax year, you can only contribute up to $3,300 if you’ve got a self-only plan or up to $6,550 if you have a family plan.
Source: IRS Publication 969