Your HSA Can Be A Stealth IRA

Most people associate the Health Savings Account (HSA) with medical expenses. I don’t blame them for making that connection. That’s the primary purpose of an HSA. It is tax-advantaged savings account for people who have a high-deductible health insurance plan.

But in reality, many people can use it as a retirement account similar to an IRA. If you don’t have a lot of medical expenses and if you have a long time horizon, you can invest the funds in the HSA in a mutual fund just like you can in an IRA. Your money will grow tax-free until you withdraw.

Let’s take a look at how HSA works and how you can maximize its benefits.

What is an HSA?

HSA was created to give people with high deductible health insurance plans an incentive to save. That’s because these plans have high deductibles that must be met before insurance pays out claims.

Any money you contribute to an HSA is tax-advantaged – that is all contributions are pre-tax. You also don’t pay any taxes when you take the money out as long as you use it for qualified medical expenses. Simple enough, right.

Take advantage of employer contributions to HSA

Many employers contribute $500 or $1000 every year to HSA accounts if you sign up for a high deductible healthcare plan. Unlike a 401(k), the employer contributions are not matches, so you can contribute as low as $1 as still get $500 or $1000 from your employer.

Investing HSA funds

Most people leave their HSA funds in cash or in a money market account, which pays you a meager interest rate. You can invest these funds in a mutual fund and get much better returns. If you are young and have many years to invest, your money can compound at 7-10%. When you invest in mutual funds, you are exposed to the fluctuations of the market but in the long run, markets have done well.

If you have anticipated medical needs, then you can set some money aside for those expenses and invest the rest in a mutual fund. Some HSAs have some minimum amount (eg. $1000) you need to set aside before you invest in mutual funds. HSA administrators do this to ensure that you have some liquid funds available in case medical expenses come up unexpectedly.

Withdrawing from an HSA

If you have medical expenses, you can withdraw from an HSA. That part is straight forward.

There is no requirement that you should reimburse yourself immediately after a medical expense occurs. For example, if a medical expense comes up, you can pay it yourself and keep the receipts. You can reimburse yourself 30 years later when your account balance has grown considerably.

What if you don’t have a lot of medical expenses? You can withdraw from an HSA at age 65 by paying taxes, just like you do with an IRA or a 401(K). Note that the minimum age for withdrawal from an IRA or a 401(k) is 59.5 years, whereas you have to be 65 to withdraw from an HSA. By withdrawing your money for non-qualified expenses, you have converted your HSA into a stealth IRA.

What happens if you no longer have a high deductible insurance plan?

If you don’t have a high-deductible insurance plan, you can no longer contribute to an HSA. But you can still spend the money in your HSA for eligible medical expenses.

HSAs are portable

If you switch jobs, you can rollover your HSA funds into your new employers’ HSA without any tax implications. You can also roll the HSA over into your own HSA (in case your new employer doesn’t offer an HSA). But keep an eye on fees. HSA administrators charge a small fee ($2-$4 per month). Your employer will pick up the fees if they offer an HSA but you will need to pay the fees if you own the account yourself.

Keep an eye on fees

Some HSAs also charge fees if you invest in mutual funds instead of keeping your funds in cash. The monthly charge is small, around $2 to $4 but these things add up. So keep a close eye on fees.

If you are investing in mutual funds, pay attention to the expenses the fund charges. Investment options in an HSA are limited compared to 401(k)s or IRAs. But by keeping fees and mutual fund expenses low, you will still come out ahead compared to keeping your money in cash or in a money market account.

Bottom Line

HSAs can be stealth IRAs for people who don’t have a lot of medical expenses and for people who are young. By moving your money from cash to mutual funds, you can grow your money at 7-10% annually. If you don’t have medical expenses, you can withdraw the money at age 65 by paying taxes on your withdrawals.

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