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Health savings accounts can keep retirement plans in shape

For healthier retirement savings, it can pay to stash cash in a health savings account.

HSAs have been gaining in popularity in recent years. At the end of 2014, consumers kept $24.2 billion across 13.4 million HSAs, according to a 2015 report from Employee Benefits Research Institute (EBRI). Nearly 4 in 5 of those accounts were opened after 2010.

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Originally meant to help workers cover medical expenses in high-deductible health plans, HSAs have become a smart consideration for retirement savings, too, said Pam O'Rourke, senior vice president and senior counsel at Integrated Retirement Initiatives, speaking to financial advisors Friday at the TD Ameritrade National LINC conference in Orlando.

HSAs are especially attractive as an extra tax-advantage retirement account for highly compensated workers who are already maxing out their workplace retirement accounts. And it could be even more attractive than an IRA for more typical consumers.

"This isn't just a few thousand a year that can accumulate," she said.

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The advantage is in the "triple tax benefit," Carolyn McClanahan, a certified financial planner and director of financial planning for Life Planning Partners, told CNBC this week. Unlike use-it-or-lose-it flexible spending accounts, HSA balances roll over year after year, with tax-free investment growth. Withdrawals for medical expenses are tax-free at any age; distributions after age 65 for other purposes will be taxed at regular income-tax rates.

But it gets better. "You have to incur the medical expense after you establish the [HSA], but you can take it out five years later, 10 years later," said O'Rourke at Integrated Retirement Initiatives. So account holders who can afford to can pay out of pocket now and save their receipts, claiming the qualified distribution after the funds have had time to grow.

The scale is also bigger. Flexible spending accounts let users set aside a maximum of just $2,550 in pretax dollars in 2016 for medical expenses, while the annual contribution limits on HSAs are $3,350 for individuals and $6,750 for families. Account holders age 55 and older can make an additional $1,000 catch-up contribution.

Everybody knows that as you get older, you're going to need more medical costs, and that's when you take it out tax-free.
Benjamin Tobias
president of Tobias Financial Advisors

Account holders may even benefit from free money in the form of employer contributions, either as a flat match or added incentive for healthy behaviors. "There's often a kick-start there to help pay for those deductibles in the first year," said O'Rourke.

Among large employers that offered a high-deductible plan and HSA in 2015, 24 percent awarded cash based on specified wellness activities, according to data benefits consulting firm Aon Hewitt. Among midsize companies, 18 percent offered such an incentive.

That's no small change. EBRI estimated that in 2014 the average employer contribution into HSAs was $1,021.

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As long-term savings, HSA funds can add up. Depending on the rate of return, someone saving the maximum for 20 years in an HSA with no withdrawals could expect to accumulate between $118,000 and $193,000, according to a 2014 EBRI report (to download the report, click here). At the end of 2014, the average balance for HSAs with an associated investment account was $6,544 for accounts opened that year and $19,269 for those opened in 2005.

It's likely to be money well saved: Health-care costs in retirement can be staggering.

"Everybody knows that as you get older, you're going to need more medical costs, and that's when you take it out tax-free," Benjamin Tobias, a CFP and president of Tobias Financial Advisors, told CNBC this week.

For a 65-year-old healthy couple retiring in 2015 and covered by Medicare parts B and D and a supplemental insurance policy, total health-care costs in retirement could total $394,954, according to a 2015 Healthview Services report (to download the report, click here). A couple retiring in 2025 at age 65 could expect to pay $463,849.

Still, use of an HSA as a retirement savings vehicle isn't a given. You must be participating in a high-deductible health plan to contribute. Those aren't universally available: In 2015, 69 percent of large employers offered an HSA, according to Aon Hewitt, and 78 percent of midsize employers.

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Nor are the plans a fit for every consumer; it depends on individual health-care needs.

Attractive five-figure savings estimates assume you won't need to make withdrawals to cover health costs in the interim, said O'Rourke at Integrated Retirement Initiatives, which just isn't feasible for many account holders. The average HSA balance at the end of 2014 was just $1,933.

Consumers also need to be smart about how those HSA funds are invested. Portability rules allow account holders to transfer their account balance to their choice of custodian, and it's important to choose one with a wide range of investment options and low fees, said McClanahan of Life Planning Partners.

Invest the money accordingly, based on your time horizon. If you expect to need it for short-term health-care costs, it's not a good idea to aggressively invest it, as you might need to cover expenses decades from now in retirement.