The Most Powerful Retirement Account You're Probably Underusing

When talking about a retirement plan, you'll often hear accounts like IRAs and 401(k)s come up. These accounts help many retirees cross the finish line with enough for a cozy nest egg, but they aren't the only savings option to consider.

Even if you have access, you may not be using it to its fullest. That mistake could cost you a triple tax advantage, which we'll explain more in this article.

Health Savings Accounts (HSAs) as a tax shortcut

You may already know that HSAs help you save taxes when used to pay for qualified medical expenses. On its own, this use can help you save hundreds or even thousands if you carefully plan out treatments, medications, and even some over-the-counter products.

But using it as a checking account for doctor bills, with only a short-term tax advantage, doesn't maximize its benefits. Where savers really get ahead is through the tax-free growth that can be used for health care costs in retirement. You can use it now or grow it later, with the smartest move often to pay for current medical bills out of pocket while the HSA money rides out the market.

Why this hold and grow strategy works

HSA money can be spent the same year you have a medical expense, but it doesn't have to be. That's where the growth potential lies, because it rolls over indefinitely and can stay invested for decades. So, it grows with the market and benefits from compounding, similar to other investments. And unlike some other medical savings options, the IRS allows earnings in an HSA to grow tax-free when used for qualified medical expenses.

For those who can afford to leave the balance be and build a separate emergency fund for medical bills, these funds can become a crucial part of a balanced retirement plan. HSAs are also portable, so no matter where you work, they can go with you.

A flexible retirement plan

When you hit 65, HSA withdrawals for non-medical expenses no longer face the 20% penalty they were subject to before. They'll still be taxed as ordinary income if you use them for non-qualified medical costs, but this is essentially how a traditional IRA behaves in retirement.

If expenses do qualify as medical costs, the withdrawals remain tax-free. This flexibility means you can use the money for qualified health costs now or as general retirement income later, assuming you don't need it all for health care in retirement.

No RMD pressure

Another benefit of these plans is that they don't require minimum distributions. While traditional IRAs and many 401(k)s make you regularly withdraw, HSA funds can keep growing untouched for as long as you wish.

Because many seniors have predictable income but not predictable medical expenses, the HSA funds fill in the gaps. It's a way to pay for uneven care costs from month to month or year to year without interfering with your planned withdrawals and income levels.

Useful for Medicare costs

HSA funds can also be used tax-free for some Medicare costs, such as Part B, Part D, and Medicare Advantage premiums, as well as out-of-pocket medical expenses. 

The medical care bucket can grow to be one of the highest costs to plan for in retirement, but its timing is often unknown. HSAs provide some assurance that there will be funds available for this budget category in any given year.

A Medicare timing warning

One word of caution for those approaching Medicare enrollment: HSA contributions must stop before Medicare coverage begins, as you'll no longer be eligible to contribute. Medicare Part A can be backdated up to six months in some cases, so experts recommend stopping HSA contributions at least six months before Medicare enrollment to avoid possible penalties.

An HSA can still be beneficial after Medicare begins, but only as a source of funds and not a place to store new contributions moving forward. A proper understanding of the timing and rules can help you avoid tax trouble.

Workplace and spouse plan considerations

If your spouse has coverage, check whether it is HSA-compatible, because a general-purpose FSA or HRA can block your ability to contribute. Married couples also need to watch the family contribution limit. If both spouses are HSA-eligible and wish to contribute as individuals, they each need their own HSA.

The cheapest health plan is not always the best choice if it limits long-term HSA benefits, so factor in any lost growth opportunities when you pick a plan.

Bottom line

HSA accounts may not be top of mind for meeting your retirement goals, but they are definitely at the top of the list for tax savings, growth, and flexibility. If your budget allows, put money into the HSA, but pay current medical bills out of pocket. Then, save your HSA receipts, as you can reimburse yourself years after the account has grown.

It's a long-term HSA play that gives you yet another (and often overlooked) advantage.

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