The Tax Trick That Lets You Save for Retirement Without Paying Taxes — Ever

Because happiness is never having to pay Uncle Sam

Piper Steele
Jun 20 · 5 min read

401(k)s and IRAs are excellent vehicles to save for retirement, but even with these tools, you still have to pay taxes on the money at some point. With a 401(k), every dollar you sock away comes right off the top of your paycheck before taxes, but when you withdraw the money, you owe taxes on it.

A traditional IRA works the same way (if you meet the income eligibility requirements for the tax deduction). And while a Roth IRA lets you withdraw your savings tax free, you fund a Roth with after-tax dollars.

There is one retirement savings vehicle, however, that lets you save up to $3,500 per year (for an individual or $7,000 per year for a family) without ever paying a dime in taxes on your contributions or your withdrawals.

Even better: The money is 100% tax free — you don’t even have to pay payroll taxes on it. Even a 401(k) doesn’t offer that benefit. You’ll still pay the 7.65% tax for Social Security and Medicare on your 401(k) contributions.

What is this amazing retirement savings plan? A Health Savings Account (HSA).

Yes, HSAs are designed to be used as an accompaniment to a high deductible health insurance plan for your out-of-pocket health care expenses. But what most people don’t realize is that you don’t have to spend all of the money you set aside each year in your HSA.

In fact, you can let your HSA savings grow well into retirement. Even better: With an HSA, you don’t have to take Required Minimum Distributions (RMDs) when you turn 70–1/2 like you do with an IRA or 401(k).

Moreover, you can invest the money just like an IRA or 401(k). And as long as you use your withdrawals to fund health care expenses, you never have to pay taxes on the money — ever!

Health Care Expenses Are a Big Deal

This may not seem like a big deal when you’re young and healthy, but medical expenses make up a huge percentage of total household expenses — 8% according to the U.S. Bureau of Labor Statistics.

And those costs go up with age. According to the Centers for Medicare and Medicaid Services, people age 65 and older spent $19,098 per year on health care expenses in 2014 (the latest year for which figures are available). That’s more than triple what a working age person spent on health care that year.

It adds up. The Henry J. Kaiser Family Foundation estimates that households on Medicare spend 14% of their income on health care expenses.

So a lot of your retirement savings is probably going to go to healthcare expenses anyway, why not use totally tax free money to fund those expenses?

It even makes sense if you’re super healthy and stay that way. Why? Because when you turn 65, you can use the money in your HSA to pay for your health insurance premiums, too. Remember, Medicare only provides the most basic coverage. Most people will add additional Medicare coverage for out of pocket expenses and drug costs.

And that’s not all. You can use your HSA money to pay for long term care insurance premiums and many routine out-of-pocket health care costs, like acupuncture, dental care, hearing aids, lab fees, vision correction surgery and even weight loss plans.

And just like an IRA and 401(k), you can invest the money you save in an HSA. Another bonus: You don’t have to use the HSA custodian your employer chooses; you can choose your own.

That’s a smart idea if your employer’s HSA provider doesn’t offer good investment choices. Many banks offer HSAs, as do discount brokers like Fidelity and Schwab.

When choosing an HSA custodian, look to see what fees are charged, what minimums are necessary for investing the money, and what the investment options are.

The Requirements

The downside to this technique, of course, is that you have to have a high deductible health insurance plan in order to take advantage of it.

A lot of people are afraid to choose these plans because the deductibles are so high — typically $5,000 to $10,000. That means you’ll have to pay all of your health care expenses up to that amount of money out of pocket. That can be tough.

If you have a serious or chronic illness, expensive medications or need costly surgery or medical devices, this technique may not be for you. But if you are reasonably healthy, it’s a nifty idea.

Even if you plan to use part of the savings for your current health care expenses, you can still let the rest of the money in your HSA grow until retirement.

Which Retirement Plan Is Best

If you’re choosing between saving in an HSA, 401(k) or IRA, a 401(k) makes the most sense to fund first, since your employer typically matches a portion of your contributions. That’s free money.

Plus 401(k)s are easy and convenient. And just having the money set aside in a restricted retirement plan will keep you from being tempted to spend it, since 401(k) withdrawals require some paperwork, and you’ll owe taxes on any money you withdraw early if you’re under age 59–1/2.

By contrast, with an HSA, you can access the money easily and may be tempted to use it for current health care expenses.

A Roth IRA makes a lot of sense, too, especially if you’re just starting out or have a tax year in which your income is lower than normal. That’s because Roth IRAs are funded with after-tax dollars, but all withdrawals are tax-free, which means the earlier you start a Roth, the lower your tax bill (presumably because you’ll make more as you get older), the more it will grow and the greater the tax benefit you get over the long term.

Of course, the best idea is to fund all three. Just be sure you meet the income requirements. That way you’ll have the benefit of free money from your employer with the 401(k) and tax-free withdrawals with the Roth and the HSA.

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Piper Steele

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Author, editor, ghostwriter. On the short list for the Noble Piece Prize, honoring women in friction who can muscle out competitors for the best piece of pie.

The Startup

Medium's largest active publication, followed by +477K people. Follow to join our community.