As your career takes off, you may be eager to save more money for retirement. Luckily, there are plenty of savings options to choose from. You may begin with your company's 401(k) and employer match. If you're looking to save more, you may also open an IRA. These are savvy moves, but there's another account to consider, too—a health savings account. Here are some things to know about this lesser-known, tax-friendly account.
How health savings accounts work
If you have a high-deductible health insurance plan, your company may offer a health savings account to go with it. Nearly half of companies make health savings account contributions, according to the 2019 Employee Benefits report from the Society for Human Resource Management. If your company offers any type of match—which is much like 401(k) matching—you should try to take advantage of it.
You can make health savings account contributions before paying tax on the money. When you're ready to spend it, you can make withdrawals tax-free on qualified medical expenses. The tax break on the front end can make a big difference when you're spending a lot out-of-pocket. Otherwise, you will have to pay taxes on the withdrawal—with a whopping 20% penalty.
Consider not spending your health savings account funds
Rather than tapping your health savings account for every healthcare expense, you could allow it to grow in your health savings account.
By making contributions year after year, and skipping withdrawals, you will have more money for medical expenses in the future. Typically, healthcare only becomes more costly as you get older, so you may be grateful the money is there. This may be especially true once you have a fixed income in retirement.
You can always reimburse yourself for qualified medical expenses anytime in the future. You can do this by saving up your receipts and repaying yourself from your HSA for those qualified expenses, as long as you were qualified to contribute to an HSA during the time period you are attempting to reimburse yourself.
Invest your health savings account balance
Another benefit of health savings accounts is long-term growth. Some companies allow you to invest the balance of your account. If you contribute and invest every year, your earnings may compound, and you may have a sizable balance within 20 or 30 years.
As the account grows, you won't pay taxes on your earnings. But unlike your 401(k), there won't be a tax bill for your withdrawals, either—as long as you're at least 65. Before that, you can withdraw the money tax-free for qualified medical expenses only.
Always weigh the pros and cons
Your health savings account comes with a built-in set of trade-offs. There are two important decisions to make—spend the money now or spend it later. By leaving the balance alone, you will pay more out-of-pocket now. This could be a financial burden if your family's budget is already tight. But if you're able to make it work—and pay for medical expenses without your health savings account—you will have the ability to invest and grow the money for years to come. And once you turn 65, you can use the money for any purpose.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.