I thought my health savings account was for medical costs only, and ended up missing a big opportunity to save more for retirement

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  • I have a high-deductible health plan and use a health savings account to pay for medical costs, but I missed out on using the account to save for retirement.
  • The IRS allows the money in HSAs to be invested, and it grows tax-free.
  • Since you deposit money pre-tax, it grows tax-free, and you can withdraw it tax-free in certain circumstances, an HSA is considered a triple tax-advantaged account.
  • Now that I know how much my money can grow, I'm investing the cash in that account.
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When you think about saving and investing for your retirement, what comes to mind?

You probably think about your workplace 401(k), and maybe you even consider an Individual Retirement Account.

While those are great places to start, there is actually a superior type of investment account (in my opinion) for retirement. It's called a health savings account, or HSA for short.

I started looking into my HSA options just a few years ago, and was surprised to learn that an HSA is actually a great way to take your retirement saving to the next level.

What is a health savings account (HSA)?

The IRS defines a health savings account as "a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to qualify for an HSA."

In plain English, an HSA is a tax-advantaged account designed to help you cover medical expenses you may incur.

To be eligible for an HSA, you must be enrolled in a high-deductible healthcare plan, which in 2020 involves having a deductible between $1,400 and $6,900 (if you are enrolled in a self-only plan).

There are a few other key health savings account rules to be aware of, most notably:

  1. You can make tax-free contributions
  2. You can make tax-free withdrawals to pay for qualified medical expenses
  3. Your money continues to roll over year after year if you don't spend it
  4. There are annual contribution limits ($3,550 for a self-only plan in 2020)
  5. You can invest funds once you reach a certain threshold (varies by plan provider) and that money grows tax-free

I know, these "rules" actually sound more like perks!

Which is why not fully utilizing the account was one of my biggest retirement mistakes that I corrected a couple of years ago.

Especially considering "rule" number five above — you can invest this money.

My retirement mistake — not utilizing my HSA

At its core, my biggest mistake was not maximizing my HSA. And what was the reason I didn't take full advantage of it?

Well, like most people, I simply didn't understand the benefit of being able to invest the money within the account. I was using it for its sole intended purpose — to cover medical expenses in the short term. It's a common mistake — only about 4% of people with HSA accounts have invested their funds.

So I only contributed a small amount during the year, and if I went to the doctor and needed to pay for a bill, I would do so from my HSA.

Don't get me wrong, using your HSA to pay for medical bills is better than not using an HSA at all. Arguably, I was using the account as it was designed to be used. But I was not using the account to its full potential.

Why this triple tax-advantaged account is great for retirement

An HSA is a  triple tax-advantaged account, which means three things:

  1. You can make tax-free contributions
  2. Your savings and investments grow tax-free over time
  3. You can make tax-free withdrawals to cover qualified medical expenses

To maximize an HSA, you should contribute funds, invest them, and watch them grow over time. Down the line when you are older and more likely to have medical payments, you can then withdraw and use the funds without any tax consequences.

And if that wasn't enough, the benefits don't stop there.

Let's say you make it to retirement with $100,000 in your HSA and are lucky enough to have no health issues and therefore no medical payments. In that case, you can still use your HSA funds on everyday expenses, you will just be taxed on them.

There is no penalty if you use the funds after age 65 for non-medical expenses. You just pay normal taxes on the money, and the account essentially becomes a second 401(k).

Now I'm back on track

Now, not only am I contributing more money to my HSA than previously, but I'm starting to invest the funds I have deposited in that account as well.

Even though I know that, mathematically speaking, investing all of the money at once is the right way to go, I'm dollar-cost averaging my investments over the next few months. It's the strategy I'm more comfortable with, even if it is just a couple hundred bucks.

Because of this change, I am putting less money into my brokerage account, but that's OK with me because I'm taking advantage of this tax-advantaged account that will benefit me down the road.

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