If you’ve done any research into saving for retirement, you’ve almost certainly heard of the most commonly recommended retirement accounts: The 401(k). The traditional IRA. The Roth IRA. Or if you’re self-employed, maybe you’ve looked into the SEP IRA or solo 401(k).
That’s the standard lineup. And they’re all great retirement accounts. They offer big tax breaks that make it easier to save your money efficiently and reach your long-term goals sooner.
But there’s one account that’s missing from that list. One account that almost no one ever talks about, but that can actually be the most powerful of them all if you know how to use it. One account that allows you to save your money completely tax-free.
The best retirement account you’ve never heard of is the health savings account.
How a Health Savings Account Works
A health savings account, or HSA for short, is a special type of account that offers multiple tax breaks when you contribute and use the money for medical expenses.
Here’s a quick rundown of how it works.
First, you need to be eligible to contribute to a health savings account, and the truth is that many people won’t be. You’re only allowed to contribute if you’re covered by a qualifying high-deductible health insurance plan, which primarily means that you have a deductible of at least $1,350 for an individual plan or $2,700 for a family plan in 2018.
If you’re eligible, you can open an HSA and start contributing And this is when the real fun starts. Because the money you contribute to a health savings account gets the benefit of a TRIPLE tax break:
- The money you contribute is tax-deductible (just like contributions to a 401(k) or traditional IRA).
- The money grows tax-free inside the account (just like all of the standard retirement accounts).
- The money can be withdrawn tax-free when used for qualified medical expenses (just like a Roth IRA, but with the medical expense limitation).
The only catch is that if you withdraw the money for anything other than medical expenses, the money is usually both taxed and subject to a 10% penalty. But there’s an exception to that penalty you’ll learn about below.
So clearly a health savings account is pretty useful when it comes to handling medical expenses. But what does any of this have to do with saving for retirement?
Why an HSA Is Such a Great Retirement Account
While you can use your health savings account to handle all your medical bills, that’s usually not the best way to use it.
Here are five reasons why you should really be using it to turbocharge your retirement savings.
1. The Money Is Yours
Unlike the flexible savings account you have through work, which offers similar tax breaks for medical expenses, a health savings account is not a “use it or lose it” plan.
The money is yours, no matter what, for as long as you want to keep it in the account. You don’t have to use it for your current medical bills if you don’t want to, and the money doesn’t disappear at the end of the year if you haven’t spent it.
You can let it sit there and grow for decades, just like a regular retirement account.
2. You Can Invest It
Some health savings accounts act much like regular savings accounts. Your money is safe and sound, earning a small amount of interest. And that’s a great way to go if you plan on using the money for your current medical bills.
But if you choose the right provider, you can invest your money for the long term just like you would within a 401(k) or IRA. Which means that you have every opportunity to grow it just like you would in any other retirement account.
3. You Will Definitely Have Medical Expenses
You might be worried about the fact that you only get to withdraw money tax-free and penalty-free if you use it for medical expenses. Isn’t that a pretty big limitation?
Not really. The truth is that medical expenses almost always increase as you age, so you can feel pretty confident that you’ll have some medical bills to pay down the line, even after Medicare kicks in.
Not only that, but you can actually use your HSA funds for past medical bills, even if it’s been years since they occurred. You just need to make sure you have good records.
And even if those two options don’t work out, the worst case scenario is still pretty good…
4. Worst Case: Treat It Like a 401(k)
Let’s say that you’re super healthy and you end up with more money in your health savings account than you need to cover your medical care. What can you do?
Well, if you wait until age 65, you can start withdrawing the money penalty-free for any purpose. It will still be taxed, but all that means is that your health savings account will essentially have acted just like a 401(k) or traditional IRA — tax deductible on the way in, taxed as regular income on the way out.
Not a bad worst-case scenario.
5. TRIPLE TAX BREAK!!!
Remember, your health savings account offers a triple tax break. You can’t get that anywhere else.
With a 401(k) and traditional IRA, you get a tax break on your contributions and your growth, but your withdrawals are taxed.
With a Roth IRA, you get tax-free growth and tax-free withdrawals, but no tax break on your contributions.
A health savings account is the only account that’s tax-free the whole way through. It’s money that you will literally never be taxed on if you use it right.
How to Use a Health Savings Account for Retirement
If you’re ready to start using a health savings account for retirement, here’s how to do it:
- Check to see if you’re eligible.
- If not, make a note to factor this into your decision the next time you’re able to switch health insurance plans.
- If you’re eligible, find a health savings account provider that allows you to invest the money in good, low-cost index funds.
- Open the account and set up automatic contributions. Annual contribution limits range from $3,450 for individuals to $6,900 for families in 2018. That’s a lot of cash to be able to save and invest on a tax-free basis.
- Use a separate savings account to save ahead for medical expenses so that your HSA money is allowed to grow for the long-term.
- Feel awesome that you know this sweet retirement savings strategy almost no one else has ever heard of.
Matt Becker is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, “The New Family Financial Road Map,” guides parents through the all most important financial decisions that come with starting a family.