It's hard to imagine retirement savings without individual retirement accounts, which have been around since 1974. Millions of Americans use IRAs to accumulate money that grows tax-deferred and in some cases, with contributions that are tax-deductible. You pay taxes only when money is withdrawn.
But for a rapidly growing number of workers, a much better option is available for accumulating retirement money: a health savings account, or HSA.
An HSA allows you to accumulate money that can later be withdrawn tax-free to reimburse yourself for medical expenses. Best of all, money you contribute to an HSA is tax-free on the way in, grows tax-free while in the account and is tax-free when you take it out. No other account allows this triple-tax-free benefit.
HSAs are so valuable that I advise clients to first take advantage of the matching contribution in their employer's 401(k) plan and then make the maximum contribution to an HSA before saving money in any other account.
To contribute to an HSA, an individual must be covered under a high-deductible health insurance plan, one with at least a $1,300 deductible ($2,600 for a family plan). The maximum annual HSA contribution in 2017 is $3,400 for individuals, $6,750 for a family. Those age 55 and older can contribute an additional $1,000.
HSAs gained traction following the 2010 passage of the Affordable Care Act, which created a surge in high-deductible health insurance plans. As more employers and individuals opted for them, the popularity of HSAs has ballooned. Assets in HSAs are projected to exceed $44 billion by the end of this year and $53 billion in 2018.
The total tax-free use of assets is a powerful feature of HSAs. But for withdrawals from an HSA to be tax-free, the money must be used as reimbursement for qualified medical expenses you've incurred.
However, you have lots of flexibility to make HSA withdrawals tax-free. You have your entire lifetime to use the money in an HSA to reimburse yourself. If you had an HSA at the time you incurred a qualifying medical expense and you have receipts to prove you weren't reimbursed, you can wait until many years later to take the money out of your HSA, tax-free.
Also, there's no age where you must begin taking mandatory HSA withdrawals, as there is for IRAs.
Because of these valuable features, I advise clients to allocate money in an HSA into long-term investments so it can grow to be used later in retirement. HSA savers should resist taking withdrawals and instead use current cash flow or other savings for out-of-pocket medical expenses.
As of last year, industry data showed that only 14 percent of total HSA assets were allocated to investments, with most held in cash. People who don't invest this money should consider putting it into mutual funds or exchange-traded funds focused on long-term growth.
What if you're allowed to contribute to an HSA but don't have the cash to do it? One option is to use money in an IRA that came from a 401(k) rollover. The rules allow for a one-time transfer of IRA assets to fund an HSA. The amount transferred can't exceed the annual contribution limits above, and the transfer, while not taxable, is also not tax deductible (because it's already from pretax money).
If you faithfully contribute to an HSA over the course of 20 years, you could contribute as much as $75,000 to $140,000 (single or family), and over that time, the investment returns could bring these accounts to double that amount, assuming an average annual 5 percent gain.
If you have money in an HSA at your death, and your spouse is the named beneficiary, your spouse becomes the account's owner and can use it as if it were her own HSA. If the beneficiary isn't your spouse, the HSA ends on your death, the account is fully paid out and is taxable as income to your beneficiary.