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Millions of savers overlook one incredibly underrated way to add extra oomph to their efforts to build a nest egg.
The health savings account is a great place to save for today’s medical expenses. But it might be an even better place to stash cash for your golden years. Here are some key reasons to consider using an HSA to save for retirement.
1. It’s triple tax-advantaged
A health savings account’s huge selling point is the fact that it is triple tax-advantaged:
- You get a tax deduction during the year of contribution.
- The money grows tax-free.
- You withdraw the money tax-free when it’s used for qualified health expenses.
In essence, if you use HSA money to pay for health care expenses, it’s never taxed. Never. It’s tough to think of any other savings vehicle that offers such a powerful combination of tax incentives.
2. It can be a back-door IRA
This is one of the most overlooked — and misunderstood — advantages of the HSA. Many people think the HSA must be used to pay for medical expenses.
In fact, once you reach the age of 65, you can withdraw your HSA funds for any reason. Just as with a traditional IRA, you will pay income taxes on the withdrawal at that point. However, you will not pay any penalties. As the IRS states in Publication 969:
Additional tax. There is an additional 20% tax on the part of your distributions not used for qualified medical expenses. Figure the tax on Form 8889 and file it with your Form 1040 or Form 1040NR.
Exceptions. There is no additional tax on distributions made after the date you are disabled, reach age 65, or die.
So, if you use the money for qualified medical expenses, it’s never taxed. If you use it for other purposes during retirement, you only have to pay the same type of taxes you would on an IRA withdrawal.
3. There’s a sneaky way to avoid those taxes
If the idea of paying taxes on nonqualified withdrawals rubs you the wrong way, there is something you can do to eliminate such fees. But it probably only works if you are a super-saver who delays using HSA funds for many years.
Some people who open an HSA account pay for their annual medical expenses out of pocket from taxable accounts instead of using their HSA funds. This allows the HSA money to continue to compound tax-free for years, and hopefully even decades.
Every time these super-savers rack up a new medical expense, they write a check to cover the bill. Then, they take their medical receipts and quietly file them away.
Why? Because as it turns out, you can ask for reimbursement of your medical expenses at any point during your lifetime. According to IRS Publication 969:
You are permitted to take a distribution from your HSA at any time; however, only those amounts used exclusively to pay for qualified medical expenses are tax free.
The key phrase, of course, is “at any time.” So, as long as your expense was a qualified medical expense — and you did not receive reimbursement or a deduction for it previously — you’re golden, even if you make a withdrawal to reimburse costs incurred decades earlier.
While news outlets such as Forbes and CNBC have written about this strategy, it remains largely under the radar. Theoretically, you could decide to buy a car when you turn 65 and fund much or all of the purchase by using thousands of dollars in tax-free HSA money. To do so, you simply have to make sure you can produce those receipts from yesteryear. Pretty neat — and totally legal — trick.