Unhealthy Strategy?

Health savings accounts are increasingly being used to stash retirement money. That may not be the smartest approach.

For some people, health savings accounts are becoming less about paying for health care now and more about saving for expenses in retirement.

HSAs, created by the federal government in 2003 chiefly as a way for employers to save on rising health-care costs, put the onus on individuals to pay for medical expenses and negotiate the best prices for procedures. The accounts allow individuals with high-deductible health-insurance plans to use pretax money to cover their medical costs. They can invest the money tax-free until they need it and pay no taxes on the investment growth and withdrawals as long as the money is used for qualified medical expenses.

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HSAs also come with a perk that's fast becoming their most enticing feature: the ability to roll over unused money year to year -- allowing people to potentially build up savings that they can use to pay for medical costs in retirement. The nonprofit Employee Benefit Research Institute estimates that medical expenses could reach as much as $164,000 for today's 65-year-old retiree who lives another 20 years.

In fact, many individuals who open an HSA seem to value it more it as a retirement-savings vehicle than as a health-care plan, says JoAnn Laing Mills, author of the Consumer Guide to HSAs and president of Information Strategies Inc. in Fort Lee, N.J., a research firm that tracks HSAs. "This is a trend that we're seeing," she says. "People are putting in as much as possible, and not touching it. They are not paying current medical bills with it. They're maximizing the contributions because of retirement."

But individuals should consider their overall physical and financial health before deciding to hoard away money in their HSAs. As a savings vehicle, HSAs really only work best for people who can afford to pay current medical costs with other money, so that the HSA money can accumulate. And financial experts stress that since there's no guarantee that individuals won't need to tap the money sooner, rather than later, to pay for unforeseen medical costs, HSAs should be used in tandem with 401(k)s, IRAS and other forms of saving -- not replace them.

Currently, an individual can contribute up to $2,850 a year to an HSA, and families $5,650. Those who are 55 and older can contribute an additional $800 each year. The amounts are adjusted annually.

Socking It Away

Chris Bateson opened a family HSA to cover himself, his wife and young child when his employer switched to HSAs in 2005, from a traditional Blue Cross plan.

Mr. Bateson, a finance director at PrintingForLess.com in Livingston, Mont., says he will use pretax dollars from the HSA to help pay for medical costs if he and his wife have a second child. But other than that, he says he'll pay most incidental medical expenses -- such as routine doctors' visits or prescription drugs -- out of pocket.

"I really do intend to preserve this for later, in order to protect my retirement funds," he says of the HSA. "I learned a long time ago, if given the choice between spending money now and putting it away for retirement, I'm the type to put it away."

Mr. Bateson, who has maximized his yearly contributions to his 401(k), believes the HSA is a better retirement-savings vehicle. At retirement, money that comes out of his 401(k) will be taxed, while money that comes out of his HSA for medical expenses won't be. "There aren't many ways to permanently protect your income from taxes -- and this is a big one," he says.

'Math Matters'

Using an HSA as a retirement-savings vehicle is not for everyone, however. Critics say the accounts only provide a retirement benefit to those who are young, healthy and financially secure enough to pay for medical expenses on their own.

Keep in mind, an individual who opens an HSA must use its high-deductible plan as his or her principal health insurance. Typically, those plans only cover catastrophic events, such as hospital stays and surgery. "I wouldn't recommend that someone who has diabetes jump into HSAs" both from a health and retirement standpoint, unless you have plenty of discretionary income, says Tom Schneider, an independent financial adviser in Farmington, Conn. Frequent doctor visits and health-care expenses could easily eat up the money in the account, leaving little -- if anything -- to roll over from year to year. "You really should be healthy to take advantage of it," he says.

Even healthy people who are thinking about switching to an HSA should tally expected medical costs and then see how much of that can be covered with discretionary income, says Jerry Ripperger, director of consumer health for Principal Financial Group, an HSA provider in Des Moines, Iowa. "Math matters at the end of the day," he says.

And you never know when you might need the money, as serious -- and costly -- health problems can arise unexpectedly. So advisers say HSAs should be viewed as investments that can be easily liquidated.

Mr. Ripperger recommends that people investing HSA money keep a portion of the balance that equals the deductible amount in a conservative money-market account, which is easy to access. Under the law, the deductible must be at least $1,100 for an individual, or $2,200 for families. Often, people opt for an even higher deductible -- as much as $2,500 for an individual, and $5,000 for a family -- to save on premiums, he says.

He says the balance can be invested in more aggressive stock funds. And for individuals who can easily cover deductibles or other medical expenses with out-of-pocket money, "it may be a totally appropriate strategy for them" to place all HSA contributions in mutual funds, he says.

But some people, looking to maximize their potential investment growth for retirement, are putting money into less-liquid and riskier places. Hugh Bromma, chief executive of Entrust Group, a retirement-plan administrator in Reno, Nev., says a handful of clients are choosing investments that combine money from their HSA, IRA and 401(k) to buy real estate. Some are even looking to alternative investments like funding the projects of oil-drilling companies.

It's a gamble for higher returns, he says, and "it's not for the unwary or the people who are risk-averse."

Small Piece of the Puzzle

Most advisers recommend investing HSAs much like a 401(k) or an IRA, typically in mutual funds. And don't get too caught up in the notion of using an HSA to build a big nest egg -- a common sales pitch by HSA providers, the government and employers who switch to them.

"The biggest selling point is for the employer to lower their medical costs, and then for the employee to control how you spend your medical" expenses, says David Schwartz, president of First Capital Equities, a wealth-management firm in Great Neck, N.Y. "I think they were really designed to do that, not add extra money to your retirement."

Don Rotanz, a self-employed real-estate investor in Chalfont, Pa., is trying to strike a balance. Mr. Rotanz, who opened an HSA to cover his family's medical expenses when he left his corporate job two years ago, says he uses his pretax contributions to simultaneously pay for his children's braces and build an extra nest egg for retirement.

But he views the account as his health plan, first, and part of his overall retirement strategy, second. He also has a Roth IRA, a 401(k) from his previous employer and investments in several rental properties, all of which will provide a stream of income in retirement. "So this is just one more thing," he says. "It's a piece -- but it's a small piece."

Ms. DeBaise is an associate editor at SmartMoney.com in New York. Write to Colleen DeBaise at cdebaise@smartmoney.com