Health savings accounts (HSAs) aren’t just for doctor visits. They can be a powerful savings tool and a massive retirement turbocharger.
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. A friend — I’ll call him Mike — told me just a few weeks ago with a straight face that he’s maxing out his 401(k) plan every year … except he wasn’t. He wasn’t even close.
Now, Mike’s a good guy. He wasn’t lying, of course. He thought he was maxing out his retirement plan.
But we’re dealing with competing terms here, and it’s easy to get them confused.
I want to sort it out because it 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 5% of your salary. You should always contribute at least enough to take advantage of the matching because, well, it’s 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:
Total 401(k) Contributions in 2021
| You contribute: | $19,500 (or $26,000 if 50 or older) |
| Your company contributes: | $5,000 (5% of 100,000) |
| Total going into your plan: | $24,500 to $31,000 |
That’s a fantastic 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 an HSA as a “spillover” retirement plan.
You see, an HSA is not a typical retirement plan. It’s 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. If you don’t need it for medical expenses, you can leave the cash in the HSA and invest it in stocks, bonds and other investments. Once you turn 65, you can take the funds out for nonmedical 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.
Note that the minimum age of 65 for penalty-free withdrawals is higher than the 59 ½ minimum for IRAs and 401(k) plans. Remember, these are designed first and foremost for health expenses, so the age corresponds to Medicare eligibility.
And here’s another fun little kicker: Unlike IRAs and 401(k) plans, HSAs don’t have required minimum distributions.
In normal retirement accounts, the IRS forces you to pull a certain amount out of your account every year. For most investors, that age is 72. 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 also must have a high-deductible health plan. Those with individual plans can contribute up to $3,600 per year (or $4,600 if you’re 55 or older). Those with family plans can contribute up to $7,200 per year (or $8,200 if you’re 55 or older).
One 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 65 and want to lower your tax bill and turbocharge your retirement savings, an HSA is a smart strategy.
To safe profits,
Charles Sizemore
Co-Editor, Green Zone Fortunes
Charles Sizemore is the co-editor of Green Zone Fortunes and specializes in income and retirement topics. He is also a frequent guest on CNBC, Bloomberg and Fox Business.
Story updated on August 10, 2021.