This lesser-known retirement savings tool is loaded with tax benefits

No matter your age or income level, your goal should be to pay the IRS as little tax as possible. And the choices you make with regard to retirement savings could have a huge impact in that regard. In fact, many workers overlook one important long-term savings tool that's actually loaded with tax benefits. And if you're forgetting it, too, you're doing yourself a major disservice.

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Why it pays to fund a health savings account

Not everyone is eligible to contribute to a health savings account, or HSA. To qualify, you must be enrolled in a high-deductible health insurance plan, the definition of which changes from year to year. For 2020, you'll need an individual deductible of $1,400, or a family level deductible of $2,800.

But assuming you do qualify, HSAs are unique in that unlike other retirement savings plans, they offer three distinct tax benefits:

1. Contributions are made with pre-tax dollars
2. Investment growth in these accounts is tax-free
3. Withdrawals are tax-free provided they're used to pay for qualified medical expenses

By contrast, IRAs and 401(k)s, which are commonly used to save for retirement, don't offer the same number of tax benefits. With a traditional IRA or 401(k), your contributions go in pre-tax, and investment growth is tax-deferred, but withdrawals are subject to taxes. With a Roth IRA or 401(k), contributions are made with after-tax dollars, while investment gains and withdrawals are tax-free. These accounts are certainly worth funding, but it's also worth incorporating an HSA into your retirement savings strategy. Though you can use an HSA outside of retirement, these accounts are best maximized when you contribute more than what you need in the near term, invest your money for added growth, and then carry those funds all the way into your senior years, when you're likely to need that money the most.

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Another thing you should know about HSAs is that normally, you'll be penalized for removing funds from your account for non-medical purposes, the same way you'll face penalties if you withdraw from an IRA or 401(k) prior to age 59 1/2. However, once you turn 65, you're actually allowed to remove money from an HSA for any reason. If you don't spend that money on medical expenses, you'll be taxed on your withdrawal -- but you'll still get the flexibility to take money out as a senior and use it as you wish.

Maxing out your HSA

The contribution limits for an HSA change from year to year, and currently, you can put in up to $3,550 if you're contributing as an individual, or up to $7,100 if you're putting money in at the family level. However, like IRAs and 401(k)s, HSA offer a catch-up contribution to older workers, albeit at a slightly later age. Once you turn 55, you can put an extra $1,000 a year into your HSA, bringing your total for 2020 up to either $4,550 or $8,100.

Best of all, unlike flexible spending accounts, you're not required to commit to an annual contribution in advance. Rather, you can adjust your contributions at any time. This means that if you've only allocated $1,000 to your HSA this year when you're actually entitled to contribute $3,550, you can still go ahead and put in that remaining $2,550.

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It's easy to disregard HSAs as a retirement savings tool since, as the name implies, they're an account intended to cover the cost of near- and long-term medical expenses. But the flexible nature of HSAs makes them perfect for your later years, and given that the typical 65-year-old couple today is expected to spend $295,000 on medical care throughout retirement, having a dedicated source of healthcare income is hardly a bad thing. Just as importantly, it never hurts to lower your tax burden as a working adult and as a retired one. Be smart with your HSA, and you'll enjoy less taxes up front, and a tax-free source of income when you're older.

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