IRA Critical Mistake #7

You’ve been very careful with your 401k, IRA and Health Savings account. You’ve been very careful with your 401k, IRA and Health Savings account. You thought you did everything right.  But ask yourself two questions:  

1. Are you eligible to contribute to a Health Savings Account?
   
   
2. Did you fail to contribute the maximum allowable amount each year?
   
   

If your answer to both questions is yes, you might be making IRA Critical Mistake #7 in THE IRA CRITICAL MISTAKES series.

How so? Read on!

IRA Critical Mistake #7 is failing to consider contributing the maximum allowable amount every year to your Health Savings Account (HSA).

Why is this a mistake? What do you risk losing if you make this mistake?

While many investors enthusiastically contribute to their 401K, Traditional IRA, or Roth IRA, they often limit or fail to contribute to their HSA.

This is frequently a lost opportunity as HSAs offer investors an additional retirement savings vehicle, additional tax deductions, and the potential for tax-free growth.

Let’s unpack some of the benefits HSAs provide below.

Tax-Deductible Contributions:  Contributions to HSA’s are tax-deductible.  This lowers your taxable income, which lowers your taxes. For 2025, the HSA contribution limit ranges from $4,300 to $9,550, depending on your age and whether your plan is self-only or family coverage.  

The 401k and IRA contributions you make do not impact the amount you can contribute to an HSA.

Tax-Free Withdrawal Potential:  Withdrawals from HSAs that are used to pay for qualified medical expenses are generally tax-free and penalty free.

401k and Traditional IRA withdrawals are generally taxable.  Tax-free withdrawals, however, for qualified medical expenses, are a significant way an HSA can have an advantage over a 401k or Traditional IRA.  Think about the amount you will spend on retirement health care costs throughout your lifetime.  Then think about how paying for these expenses could come from tax-free withdrawals from your HSA.

It is very unusual for a retirement savings account to receive a tax deduction upon contribution and be tax-free upon withdrawal.  The HSA can provide this opportunity.

Additional Retirement Savings Vehicle:  HSA contributions can usually be invested in stock and bond mutual funds.  Some HSAs offer additional investments options as well.
Investing in stocks and bonds carries the risk of losing money, and, accordingly, should be considered as part of a diversified, long-term investment strategy. 

This can make the HSA an excellent companion tax-advantaged retirement savings vehicle alongside your 401k, Traditional IRA and Roth IRA.  

Consider contributing the maximum allowable amount each year to your HSA even if you are not sure you will use the funds someday to pay for qualified medical expenses.

If you believe withdrawals from your HSA might not be used to pay for qualified medical expenses, it is important to understand the potential 20% IRS penalty.

HSA withdrawals used to pay for qualified medical expenses are generally tax-free and penalty-free during your lifetime. Before age 65, in addition to being taxable, withdrawals from HSA’s that are not used to pay for qualified medical expenses will also incur a 20% IRS penalty.

If you believe you will need to withdraw funds from your HSA before age 65 for reasons other than qualified medical expenses, you may wish to reconsider contributing to an HSA.

After reaching age 65, withdrawals from HSA’s are still taxable, but withdrawals for reasons other than qualified medical expenses no longer incur the 20% IRS penalty. This means that, after reaching age 65, withdrawals from HSAs for reasons other than qualified medical expenses are generally taxed like withdrawals from a 401k.

• Determine if your employer offers a Health Savings Account (HSA).
  
  
• Discuss with your financial or tax advisor contributing the maximum allowable amount each year to your HSA if you believe you will not withdraw funds from your HSA prior to age 65 for reasons other than qualified medical expenses.