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(Should You) Fund Your HSA Before Your IRA?


The HSA (Health Savings Account) has been around for decades, but is not widely understood. This is partially because not everyone qualifies for one. If you do qualify, it might help your current budgeting, as well as potentially providing a boost for your later retirement funding. Originally sponsored by Sen. Ted Kennedy and others, the HSA was a wonderful idea – so good, in fact, that Congress limited the number of people who could open one in any given year. What a ridiculous way to treat a good idea!

HSAs are used in conjunction with qualified high-deductible health insurance policies, which are low in cost due to their large annual deductibles. Amounts contributed to HSAs are tax deductible, and qualified medical bills may be paid pre-tax from the HSA. But, those bills don’t have to be paid from the HSA. This is where the HSA as a retirement planning tool captures our attention.

People whose cash flow allows them to pay out-of-pocket medical bills from their monthly income do not need to withdraw funds from the HSA. Annual HSA contributions are tax-deductible in the year made, and any unused money in the account is rolled over from year to year. While the HSA cannot be funded further after age 65, funds remaining in the account at age 65 can be used for paying qualified medical expenses incurred beyond that age.

Regardless of when the funds in the account are tapped, as long as they are used for qualified medical expenses, withdrawals are not taxed. This setup essentially creates a hybrid of the Traditional IRA and Roth IRA. What a deal!  Deductible funds in, non-taxable medical expenses out, and applies even to earnings and investment growth in the HSA.

Depending on the custodian of the HSA assets, the owner may be able to invest in a panoply of market-based assets, the same as a Traditional IRA. For those who are able to pay their daily medical expenses out of pocket, their HSA amounts to an additional IRA, and can make a significant impact on both current taxes, as well as future retirement expense reduction and/or income enhancement.

Like Traditional IRAs, HSAs have named beneficiaries. Therefore, a surviving spouse can inherit the HSA as his/her own, and continue to pay family medical expenses just as before. It might seem likely that HSA contributions would be mutually exclusive with Traditional IRA deposits, but that is not the case. Having both is allowable, as they are independent of each other. Contributions to both in any tax year are deductible, although IRA deductibility is subject to the usual income limitations.

Should a person who is eligible for both a Traditional IRA and an HSA, but is financially unable to fully fund both, start with the HSA? We doubt that many people have ever pondered that dilemma. There are instances where starting with the HSA makes more sense, especially for young, healthy people, without sufficient cash flow to fully fund both the HSA and the IRA. These people have very low annual medical bills, and may be able to leave most of their annual HSA contributions in the account for future compounding.

Saving money is the quickest and surest way to make money, and Van Wie Financial is constantly striving to help the process through education.

Van Wie Financial is fee-only. For a reason.