Don’t dismiss it just because the word “health” is in the title, HSAs can be a powerful retirement savings tool.
If you’re on track to max out your 401(k) this year, congratulations! You’re building your next egg while sticking it to the taxman. Pat yourself on the back!
But before I go any further, let’s make sure we’re on the same page. I’ve chatted with dozens of people who told me with a straight face that they were maxing out their 401(k) plans every year … except they weren’t. In fact, they weren’t even close.
They weren’t lying, of course. They legitimately thought they were maxing out their retirement plans. But there are a lot of competing terms here, and it’s easy to get them confused.
Let’s sort this out because this can save you thousands of dollars a year in taxes and hundreds of thousands or even millions over the course of your investing life.
Your employer might match your 401(k) contributions up to 3% to 5% of your salary. You should always contribute at least enough to take advantage of the matching because it is literally free money. But “matching” and “maxing” are not the same thing.
You can contribute up to $19,500 to your 401(k) this year or $26,000 if you’re 50 or older. This is the maximum you can put in, not including your employer matching or any profit sharing.
Let’s play with the numbers.
Say you earn an even $100,000 per year, and you make it your goal to max out your 401(k) plan for the year. Let’s also say that your employer offers 5% matching. This is how that would shake out:
That’s a great start.
But let’s say you’re a fanatic about saving like I am, and you’ve managed to max out the full $19,500. Now you’ve caught the saver’s bug and you want to save even more. That’s where HSAs come in.
Use an HSA to Turbocharge Your Retirement Savings
If your health insurance plan includes them, you can use a health savings account (HSA) as a “spillover” retirement plan.
This requires a little explaining. HSAs are not a typical retirement plan. They’re designed to help you save for health expenses by giving you a tax break.
As with IRAs or 401(k) plans, any money you put into an HSA gives you an immediate tax deduction. A dollar invested in an HSA lowers your taxable income by a dollar. And you can take cash out of an HSA at any time tax- and penalty-free if you use it to pay for qualifying medical expenses.
But here’s where it gets fun.
No one says you have to spend the money. You can leave the cash in the HSA account and invest it in stocks, bonds and other investments. Once you turn 65, you can take the funds out for non-medical purposes penalty-free.
You’d still owe taxes on it, but the same would be true of any cash taken out of an IRA or 401(k) plan.
So, you can use an HSA as a “spillover” IRA for the extra cash you want to invest tax-deferred.
And here’s another fun little kicker. Unlike IRAs and 401(k) plans, HSAs don’t have required minimum distributions (RMDs).
In normal retirement accounts, the IRS forces you to pull a certain amount out of your account every year after you hit the age of 70 ½ (these rules were relaxed in 2020 but will be back in 2021). HSAs don’t have that requirement, so you can let your funds grow and compound tax-free well into your golden years.
In order to use an HSA, you have to also have a high-deductible health plan. Those with individual plans can contribute up to $3,550 per year (or $4,550 if you’re 55 or older). Those with family plans can contribute up to $7,100 per year (or $8,100 if you’re 55 or older).
There is a caveat. If you’re already over 65 and on Medicare, you can’t add new money to an HSA plan. But if you’re under the age of 65 and are looking to lower your tax bill and turbocharge your retirement savings, an HSA can be a great way to do both.
Money & Markets contributor Charles Sizemore specializes in income and retirement topics. Charles is a regular on The Bull & The Bear podcast. He is also a frequent guest on CNBC, Bloomberg and Fox Business.
Follow Charles on Twitter @CharlesSizemore.