Can’t Contribute More to Your IRA? Consider an HSA Instead

IRAIf you find that you are curious about the benefits of opening an HSA, or health savings account, you are not alone. The HSA is one of the more popular new health care management tools on the market today. It also offers several other attractive benefits beyond the simple ability to choose how, where, when and with whom to spend your health care dollars. One of these benefits is the flexibility of the HSA to function as a savings and investment account. For some people who are close to maximizing their annual contributions to an IRA (individual retirement account), opening an HSA account begins to look like a particularly attractive retirement planning option. Before you decide to open an HSA as an alternate savings vehicle, however, it is important to understand how these unique accounts function.

The HSA Defined

The health savings account is a relatively new entrant into the greater health care arena. For employers, the HSA is a way to help employees take charge of their health care choices and also to save money on insurance-related overhead expenses. Opening an HSA allows employees to plan for future unknowns in health care and life. The formal definition of an HSA according to the Internal Revenue Service (IRS) is “a tax-exempt custodial account that you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur.” The trustee is an IRS-approved individual who has earned the credentials to allow him or her to manage financial accounts on behalf of others.

How the HSA Works

Learning what is a health savings account and what isn’t, who is eligible to open an HSA and how the funds can be used can pave the way towards deciding if this type of investment vehicle is the right choice for your needs.

  • HDHI. The HSA is designed to work in a complementary way with the high-deductible health insurance (HDHI) plan. Only participants in an HDHI are eligible to open an HSA as well.
  • Tax-free contributions. The funds deposited into an HSA are tax-free until a distribution is taken. At that time the distribution is taxed like ordinary income.
  • HSAs and health care costs. While there are undeniable tax and savings advantages to opening an HSA for qualified participants, it is important to remember that the primary purpose for the HSA in the eyes of the IRS is for managing health care expenses.
  • Penalties for withdrawals. As with IRAs and other similar retirement-focused investment accounts, a 10 percent penalty will be assessed for any non-health care related withdrawals made before the age of 65.
  • Income reduction. Because contributions to an HSA account are not considered income, maximizing contributions can help reduce annual income for both federal and state income tax purposes.
  • HSA funds can be used for non-traditional health care expenses. In addition to qualified medical expenses, the funds deposited into an HSA account can also be used for vision, dental, alternative and other types of medical care, including Medicare expenses.
  • HSA funds can be directed towards other purposes. While there is a 10 percent penalty for withdrawal before age 65, and withdrawals are taxed in the year of withdrawal regardless of the participant’s age, there is no restriction on how withdrawn funds can be directed, making it a handy account to turn to in times of crisis or the simple unexpected.
  • Contribution limits. The IRS sets the contribution limits annually. These limits are typically based on the cost of each individual’s annual insurance coverage expenses and are rounded up to the nearest $50. Over-contribution will trigger an automatic six percent financial penalty plus normal assessed income taxes on the amount of over-contribution.
  • Contribution cutoff dates. The cutoff for contributing to an HSA account in any tax year is April 15.
  • Tax forms. IRS Form 8889 is the official tax form that is required for HSA account holders.

Retirement Planning

One of the single best benefits of choosing to open an HSA as part of your investment planning is that all accrued funds can be used to pay long-term health care and living expenses once you reach age 65. With this additional benefit, it is easy to see why the HSA has become such a popular investment vehicle. 

Minolta DSCAbout the Author: Wiley Long has been helping individuals and families get coverage and save money for over 20 years. He owns HSA for America.

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