retirement

A New Direction for Retirement Savings

Use a health savings account to supplement your IRA or 401(k).

Looking for another way to benefit from tax breaks on saving for retirement? Then take a gander at the new, improved health savings account.

HSAs started out as a way to help pay medical expenses. To qualify, you had to sign up for a health-insurance plan with a high deductible -- at least $2,200 for family coverage and $1,100 for individuals. You could then open an HSA and contribute an amount up to your deductible, with a maximum in 2007 of $5,650 for families and $2,850 for individuals.

But in December, Congress passed a last-minute law that lets you contribute the maximum amount to an HSA regardless of the amount of your deductible. So, for example, you can buy a family policy with a $2,200 minimum deductible and contribute as much as $5,650 to your HSA.

The change makes it more appealing to use an HSA for long-term savings instead of just medical expenses. "This has moved the HSA into the realm of financial-planning tools," says Jerry Ripperger, director of consumer health for Principal Financial Group.

That's especially true because the tax benefits HSAs enjoy are tough to duplicate. Contributions are tax-deductible, and money in an account grows tax-deferred. Regardless of your age, withdrawals are tax-free if you use the money for medical expenses. Withdrawals for other purposes are taxable, plus you'll pay a 10% penalty. After age 65, however, you can withdraw money penalty-free (and you will only owe income tax if you use the money for nonmedical expenses).

The expanded contribution levels make HSAs attractive if you've maxed out on other tax-advantaged savings options. Ripperger expects HSA administrators to expand investment choices by offering mutual funds for long-term savers.

In the past, the maximum contribution to an HSA was permitted only if you enrolled in January; contributions made later in the year were prorated. Now you can make the full annual contribution no matter when you enroll.

Under the new rules, you can also roll over money from an IRA to an HSA and use it tax-free for medical expenses. You can take advantage of the rollover only once during your lifetime, and it's limited to the maximum annual HSA contribution. But it can be a source of tax-free money to cover big medical expenses or to help you jump-start your HSA for future savings.

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