Want to know what you can do now to save and invest for your future? You might hear that a Roth IRA is your best bet, and it's sound advice for a few reasons.
You pay tax on your contributions to a Roth IRA today, but not when you make withdrawals from the account in the future. Because many people expect to be in a higher tax bracket down the road (since they hope to be earning more later in their career), it makes for a tax-efficient savings strategy since you pay less in taxes now. It also means anything you earn in a Roth is tax-free.
You can also contribute to retirement accounts like 401(k)s or SEP IRAs. These accounts are tax-deferred, meaning you can deduct your contributions from your current tax bill -- but you'll pay taxes when you withdraw the money in the future.
Pairing a tax-deferred account with something like a Roth gives you a balanced approach to retirement savings. But wouldn't it be nice if an account existed that allowed you to contribute money tax-free, withdraw money tax-free, and enjoy the earnings of the account tax-free?
There's good news if you're interested. An account like this exists and can help you build your wealth if you know how to use it.
How an HSA can help build your nest egg
Health savings accounts, or HSAs, are tax-advantaged accounts. The money you contribute is free from income tax. You can invest in stocks and funds within your HSA, and any investment earnings are free from tax, too. When you spend the money in your HSA on qualified healthcare expenses, that money is also tax-free.
The HSA is designed to help you reduce your taxable income while building a cash reserve that you can use for medical expenses. But how does that help with building wealth and funding your retirement?
HSAs are special because, in addition to the tax benefits, the money you contribute rolls over from year to year. You don't have to spend it. (This is different than the similarly-named FSA, or flexible spending account. You do need to spend money you put in an FSA, or else you lose the funds at the end of the year.)
If you can contribute to your HSA throughout your young, healthy years and not dip into the funds, you'll have a sizeable nest egg you can dedicate to medical expenses in retirement. That's a big deal, since medical costs might be your single biggest line item that threatens to bust your retirement budget.
Fidelity estimates average healthy couples aged 65 will spend $245,000 on healthcare throughout their retirement. That assumes they can use federal aid like Medicare and does not include costs like long-term care or OTC medications.
That's a lot of money -- and you get taxed on that spending. But what if you funded your HSA throughout your working years, used your normal income and budget to pay for healthcare as you needed it, and only used the money in your HSA after you retired?
The current maximum contribution to an HSA is $3,400 for individuals under 55. Let's say you're 30 years old and contribute that maximum to your health savings account until you retire at age 65, you'd have $325,482.22 (assuming a 5% return).
You could spend every bit of that money to take care of your healthcare needs -- all without paying taxes on a dime of it. If you can use an HSA this way, it will help you manage a huge retirement expense while minimizing the taxes you need to pay on the money you life off of later in life.
Who can use an HSA?
Before you rush out to open your own health savings account, know there's a caveat: you can only open one if you currently have a high-deductible health insurance policy. These are known as HDHPs, and the IRS considers individuals with a plan that includes an out-of-pocket maximum of $6,550. The minimum deductible must be $1,300.
High-deductible plans may not make sense if you currently suffer from health issues or concerns and require a lot of treatment and care. But if you're young, healthy, and don't often visit doctors or specialists, you can enjoy a lower monthly premium and save in an HSA.
If you choose to take on a HDHP so you can use an HSA, make sure you have enough in cash reserves to use in case you need to pay the full amount of your deductible. That way, you know you can immediately pay for any medical issues that crop up -- without pushing yourself into debt or breaking into your HSA before you give your contributions a chance to grow.