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Could a Roth HSA Be Right for Me?

Medical expenses continue to be a challenge for many Americans, even as more people are insured because of the ACA.  In an effort to control rising premium costs, insurers have introduced a variety of high-deductible policies that are compatible with Health Savings Accounts (HSAs), tax-free savings that can be used to cover medical expenses not covered by an insurance policy. Individuals with these kinds of accounts are really getting insurance in two ways: via a third party with their policy premiums, and self-insuring with their HSA deposits. There are, however, very strict rules that govern which insurance policies are compatible with HSA's, which means that it may be difficult for an individual to continue making contributions in the event of a change in insurance policy. A Roth HSA is an investment vehicle being proposed as a way to solve this problem.

What is a Roth HSA? Like its relative, the Roth IRA for retirement savings, it is funded with post-tax deposits by the individual, but all withdrawals are tax-free. This makes it an attractive option for people who are currently in a low tax bracket but anticipate being in a higher bracket when it's time to make withdrawals.  A Roth HSA would offer several other advantages over the current pre-tax HSA option; here are some to consider.

Roth HSA funds can be withdrawn to cover eligible medical expenses during the insurance period--and for any purpose whatsoever when the insurance period is complete.  This structure encourages consumers to make generous contributions to their Roth HSA, not only protecting them against unexpected medical expenses, but rewarding them with money available for other purposes if they stay healthy. Proponents of the Roth HSA concept believe that consumers will make wiser choices about their health care if they have a choice between spending their savings on health care or other items, rather than--as in a traditional HSA--being limited to spending it only on health care.

Funds in a Roth HSA are deposited after taxes, so withdrawals cannot be taxed, although a penalty may apply if withdrawn for non-medical purposes during the insurance period. Withdrawals from a regular HSA are only tax- and penalty-free if they are used for eligible medical expenses. After age 65, consumers can withdraw HSA funds for a non-medical purpose without a penalty, but the withdrawal will still be taxed. Individuals who anticipate a high tax rate in retirement or who hope to minimize taxes to their heirs may benefit from this feature.

A Roth HSA maximizes consumer choice.  By funding an HSA with post-tax dollars,  consumers free themselves from the regulatory limits on pre-tax investments, and open up a more flexible landscape for long-term planning. John C. Goodman at Forbes describes this landscape as an ongoing balancing act of these four choices:

  • Between third-party insurance and individual self-insurance
  • Between health care and other goods and services
  • Between current health care and future health care
  • Between future health care and future other goods and services

A Roth HSA isn't available yet to consumers; proponents are hoping to convince legislators to make more insurance policies compatible with HSAs before introducing it. Hopes are high for its success, however. Like the Roth IRA that preceded it in the retirement savings toolkit, the Roth HSA specifically addresses the need for flexibility when planning for the unpredictable.  No one truly knows what healthcare challenges lie ahead, or what their financial impact may be.  Any HSA will make tax-free funds available to meet those healthcare challenges when they happen.  Only a Roth HSA will make those same funds available tax-free for other purposes if you stay in good health.