Retire Richer! Use Your Health Savings Account to Boost Your Nest Egg

More than 13.5 million people now use Health Savings Accounts (HSAs) to set aside pretax dollars for their medical expenses. But because you don’t have to use the money in an HSA by any particular deadline, HSAs also can serve as powerful savings tools to supplement your retirement accounts or to provide some emergency cash.

As a former senior adviser to the Secretary of the US Treasury for health initiatives, I helped implement HSAs nationwide a decade ago. Their features make them far more useful, flexible and valuable than most people realize.

One of the greatest advantages is that, unlike the more popular Flexible Spending Account (FSA) that requires employees to predict their medical spending for the year in advance and contribute a defined amount, the IRS allows you to fund your HSA with pretax dollars after a medical expense* has occurred, then immediately reimburse yourself. In fact, you have until April 15, 2014, to fund your HSA for 2013 expenses.

Smart strategies for using HSAs…

Pay insurance premiums. You might know that if you change jobs or lose your job, you still keep your HSA and have access to all the money you have contributed. That means that even if you aren’t eligible to make contributions because you are no longer enrolled in a high-deductible health insurance plan, the money still can be withdrawn tax-free and penalty-free to cover medical expenses.

But you might not know that if you get fired, laid off or quit your job, the IRS allows you to use HSA money to pay premiums for temporary COBRA health insurance coverage. Moreover, if you are receiving federal or state unemployment benefits, you can tap your HSA to pay the premiums for any health insurance coverage.

Once you turn 65, HSA flexibility increases even further. At that point, the IRS allows you to withdraw your HSA money tax-free and penalty-free to cover your premiums for Medicare and long-term-care insurance.

Supplement your nest egg. You might know that the money in your HSA account can be invested and can grow tax-deferred just like your IRA assets in investments such as certificates of deposit, stocks, bonds and mutual funds, depending on which kinds of investments your HSA provider offers.

But you may not know that once you turn 65, HSA money can be used—without paying a penalty—for any reason, medical or otherwise, although if you use it for purposes other than qualified medical costs or insurance premiums, you have to pay income tax on the withdrawn amount.

That makes the HSA so attractive that I often recommend that while someone is employed, he/she should fund it to the maximum allowable amount year after year—even before fully funding IRAs and even if he doesn’t expect to spend nearly that amount in the same year he makes the contribution.

I also recommend that if someone can afford to, he should consider paying for all or a portion of medical expenses with non-HSA money in years when he is contributing to his HSA. That way, HSA investments can grow tax-free, as they would in an IRA, for many years.

Leave your HSA to your spouse. When you die, your HSA can be transferred to your spouse tax-free, and it becomes his/her HSA. The surviving spouse can continue to make contributions if otherwise eligible to do so and can use the HSA money to pay for qualified medical expenses or for other purposes outlined above. However, if your HSA is left to a beneficiary other than your spouse, it converts to a regular bank account upon transfer and loses any tax advantages.

HSA RULES FOR 2013

To qualify for an HSA: You must be enrolled in a high-deductible health insurance plan, which means that insurance does not pick up your health-care costs until you meet your annual deductible, which must be at least $1,250 for singles and $2,500 for families. After that, your insurance covers additional expenses. Your maximum annual out-of-pocket expenses under the plan (including deductibles, co-pays and co-insurance) cannot exceed $6,250 for an individual with self-only coverage or $12,500 for an individual with family coverage.

To contribute: You can put up to $3,250 for individuals and $6,450 for families in your HSA this year. That includes money your employer may contribute to your HSA. If you are over age 55, the IRS allows you to add an additional $1,000 annually over your HSA contribution limits.

*HSA money can be used tax-free for only “qualified” medical expenses, which include most ordinary procedures, treatments and prescribed medications but not over-the-counter medications, vitamins or cosmetic surgery. HSA contributions are deductible for federal income tax and for state income tax in all states except Alabama, California and New Jersey. If you withdraw HSA funds for unqualified medical expenses before age 65, you are subject to a 20% penalty plus income tax on the amount withdrawn.