Follow These 5 Tips to Make the Most of Your Health Savings Account

Follow These 5 Tips to Make the Most of Your Health Savings Account

A health savings account (HSA) remains one of the best personal finance tools available to you. You can open an HSA if you have a high-deductible health plan as a way of saving for medical costs. The money in an HSA can be invested, depending on the amount, and that money grows on a tax-free basis, which is why HSAs have become popular as an alternative retirement savings account.

Money gets deposited into the account prior to paying income taxes, and it can be withdrawn tax-free (provided that it goes toward qualified health expenses). Because of this setup, an HSA is considered a triple tax-advantaged account that can significantly help cover medical costs in retirement. Read on for some tips to keep in mind when it comes to funding an HSA.

1. Invest the money.

As already mentioned, one of the big benefits of an HSA is that it allows you to invest your money. If you have an HSA, you should talk to the account provider and ask about investment options to figure out which would meet your particular goals while remaining within your risk tolerance.

With traditional retirement accounts, investors usually reduce their risk exposure over time to protect wealth as they grow closer to retirement. If you depend on your HSA to cover medical expenses, risky investments may not be the best decision even if you are relatively young. Speak with a financial advisor if you need help deciding on risk tolerance for such an account. Some accounts will require a certain minimum before investing is possible. If this is the case, be sure you consolidate all HSAs from previous employers to reach that mark quickly.

2. Contribute as much as possible.

One of the downsides of an HSA is that you are limited in how much money you can invest each year. Plus, the maximum is subject to change each year, and there are different limits for individuals and families.

As much as possible, strive to hit this annual maximum each year to take full advantage of the tax benefits of the account, especially in your younger years when you are healthier and will not likely need to dip into the account. Doing so will allow you to take advantage of the power of compounding interest for the investment money. Also, you should know that you can transfer from a traditional or Roth IRA into an HSA once per lifetime. While the same contribution limits apply, this can be a way to fund the account quickly. Furthermore, some employers will contribute to an HSA, so be sure to ask if yours does.

3. Use the money wisely.

Unlike a flexible spending account, the money in an HSA rolls over from year to year, so there is no reason to dip into the funding for smaller medical expenses. While you may need the money for unexpected medical expenses, you maximize your retirement savings by touching the account as infrequently as possible. Also, you may want to consider reimbursing yourself for medical expenses to keep the account funded. Remember that you can only use the money for qualified medical expenses until you turn 65. Before that time, you will pay both taxes and a 20 percent penalty on withdrawals when the money is used for nonqualified reasons. After you turn 65, you will pay taxes but not the penalty when using the money for nonmedical expenses.

4. Adopt a long-term viewpoint.

While you save money in your HSA and then invest that savings, keep in mind the benefit of having the account in retirement. Since HSA funds do not retire, you can continue to save through retirement and then use the money for qualified health expenses to continue benefiting from the account’s unique tax situation. Many people use the money saved in their HSAs to cover Medicare premiums or long-term care insurance premiums without needing to pay tax on that money. Even if you have more money in the account than you expect to spend on health care, you will just need to pay taxes on money withdrawn once you turn 65. In other words, the account also functions much like a 401(k) without required minimum distributions and additional tax advantages for health-related spending.

5. Name a beneficiary.

Just as you should with any financial asset, assign a designated beneficiary for your HSA. In many cases, this beneficiary should be your spouse. This is because your spouse will then be able to assume ownership of the account should you pass first. Your spouse will be able to continue using it as before with the same rules. The money continues to grow without accruing any taxes. If you name a beneficiary other than your spouse, that person will still get the money. However, the money will get taxed during the transfer process, as it gets counted as general income. The recipient can, of course, reinvest the money, but the overall tax benefits of the account will be lost.