This retirement savings account is at least 17% better than a 401(k), says one expert: It’s ‘a complete cheat code’

Soon you’ll be able to put a lot more money into your health savings account.

Last week, the IRS announced the largest-ever increase in maximum contributions to popular savings vehicles.

In 2024, the maximum HSA contribution will be $4,150 for an individual and $8,300 for a family, up from $3,850 and $7,750, respectively, in 2023. Add the additional $1,000 you can contribute if you’re over age 55 and the maximum contributions are $5,150 for individuals and $10,300 for couples.

That’s a big problem for long-term savers. That’s because, used to its full potential, an HSA can be a more powerful retirement savings account than more conventional vehicles like 401(k)s and individual retirement accounts.

Consider a calculation by Blake Hilgemann, financial advisor and author of the “Pathway to Financial Independence” newsletter: “Every dollar in an HSA is worth at least 17.65% more than a dollar in a 401(k).” wrote in a recent tweet.

Hilgemann’s arithmetic works because of the unique tax advantages of an HSA. Unlike other types of tax-advantaged retirement accounts, HSA contributions and investment earnings are never taxed, as long as you follow the rules when making withdrawals from the account.

That means you avoid paying income tax on your withdrawals, which, at current rates, is at least 10%. And because HSA funds aren’t subject to the 7.65% payroll tax owed by employees, you get at least a 17.65% advantage when you save in one, says Hilgemann.

That’s especially powerful for people who are, or hope to eventually be, high-income. “If you’re in a high tax bracket, an HSA is a complete cheat code for you,” Hilgemann told CNBC Make It.

Here’s a closer look at why HSAs can be more powerful than other retirement accounts.

If you invest in a traditional 401(k) or IRA account, you get an immediate tax advantage: The money you invest in these accounts can be deducted from your taxable income for the year you made the contribution.

In exchange for the up-front tax cut, you’ll owe income taxes on any money you withdraw from these accounts in retirement. And if you withdraw the money before age 59½, you’ll owe the tax plus a 10% penalty.

But investing in an HSA comes with a triple tax advantage. As with a 401(k), contributions to these accounts can be deducted from your taxable income. As long as you’re in the account, your investments grow tax-free. Then, when you withdraw the funds, you won’t owe any taxes as long as you put the money toward qualified medical expenses.

It’s easy to see why Hilgemann stressed that you can save “at least” 17.65% with an HSA, because if you’re in a higher tax bracket, you can save significantly more by avoiding income tax. Currently, single taxpayers who earn more than $578,125 pay a maximum federal marginal income tax rate of 37%.

To contribute to an HSA, you must be enrolled in a high-deductible savings plan, a type of health insurance with a deductible (the amount you must pay out-of-pocket before your insurer begins to cover costs) of at least $1,500 coverage and $3,000 for family coverage.

As with the more common flexible spending account, you can make automatic pre-tax contributions from your paycheck to help finance health care costs. But unlike an FSA, HSAs don’t come with a “use it or lose it” provision.

Instead, the money is kept in an account that belongs to you. And once it’s in your account, you can invest it however you see fit: in stocks, bonds, mutual funds, exchange-traded funds, and other types of securities. The longer you stay invested, the more time your investments will have to create returns that compound over time.

“The most important aspect of an HSA, even more important than the triple tax savings, is the adaptability of its use through the various stages of a person’s life,” says Kevin Robertson, senior vice president and chief revenue officer at HSA Bank. “Every American, at some point in his life, will either be a spender or a saver for health care needs.”

However, in order to use an HSA as a retirement savings vehicle the same way you would a 401(k) or IRA, you’ll need to be comfortable paying out-of-pocket health care expenses, at least until you meet your deductible each year.

If you have consistently high health care costs, this can get expensive quickly and a plan with a lower deductible may be more appropriate for you.

However, if you can cover your costs in the short term, you can build powerful retirement savings tax-free.

Remember, the money is only tax free if you use it for medical expenses. But if you’re strategic about it, it should be easy. For one thing, you probably have medical bills to pay when you retire. In 2022, the average 65-year-old retiree couple would need approximately $315,000 to cover health care expenses in retirement, according to Fidelity.

Plus, your medical expenses don’t have to be contemporaneous to count when you withdraw the money. Over the years that you cover your out-of-pocket expenses, be sure to save your receipts digitally.

“Those expenses never go wrong. You can have 20 years of expenses, and then when you retire, you want to take a fancy vacation,” Jeremy Finger, certified financial planner and founder of Riverbend Wealth Management, told CNBC Make It. “You can pull out $15,000 from your HSA and use those receipts to make your withdrawal tax-free.

In other words, as long as you have receipts for medical expenses, you can reimburse yourself and use the money for whatever you want. Nor is it a bureaucratic process in which you will have to present the expenses to get the money.

“Everything is justified by itself,” says Robertson. “It’s between you and the IRS as long as you have the receipts to back up your claims in case you ever get audited.”

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