There are secret weapons to build wealth that are accessible to just about everyone: tax-advantaged accounts. Some are designed specifically for retirement, and others are only for certain types of expenses, such as education or medical bills.
Many people don’t even know that these powerful tax-advantaged accounts exist, much less how to use them to improve their finances. This important information is rarely taught in U.S. schools — but that’s another article.
I’ll explain a couple of benefits and limitations that are the reasons I max out a health savings account (HSA) every year and skip contributions to an individual retirement account or IRA.
IRA Benefits You Should Know
An IRA is terrific because it’s available to anyone with some amount of earned income. You can save an amount up to your annual taxable income or the annual IRA contribution limit, whichever is less.
The Internal Revenue Service (IRS) just announced that starting in 2019, you can contribute an additional $500 to either type of IRA, or up to $6,000. And if you’re over age 50, you can save a bit more — up to $7,000.
For example, if you’re 55 years old and earn $80,000 a year as a graphic designer, you could save $7,000 in an IRA starting in 2019. But if you’re in high school and make $4,000 working a summer job, you can only contribute up to $4,000.
Money saved in a traditional IRA is tax-deductible, which reduces your taxable income in the same year. However, the contributions and earnings in the account are taxed as ordinary income when you take withdrawals down the road in retirement.
With a Roth IRA, contributions are taxed — but future withdrawals of contributions and earnings are typically tax-free. This can make the Roth a better choice if your retirement is many years away.
More on Saving for the Future: Here’s How Much People Have Saved for Retirement in Every State
IRA Limitations You Should Know
While IRA benefits are fantastic, these accounts come with limitations. Unlike a traditional IRA, which has no restriction on income, high earners are not allowed to contribute to a Roth IRA.
Additionally, when you or a spouse also have a retirement plan at work, such as a 401k or 403b, contributions to a traditional IRA may not be tax-deductible when you earn above an annual threshold. Note that you can still put money in a traditional IRA, but you may not get the full tax deduction.
This restriction for having multiple retirement accounts doesn’t exist with a Roth IRA. But, as I mentioned, you’re locked out of a Roth IRA altogether when you have a high income.
These restrictions are what prevent me from using either a traditional or a Roth IRA. I’m self-employed and don’t have a workplace plan — but my husband does. Since we file taxes jointly, that’s a strike against the traditional IRA because contributions wouldn’t be tax-deductible for us.
And, our income prevents me from contributing to a Roth IRA. So, the best option for my situation is contributing to a small business retirement account known as a simplified employee pension, or SEP. I layer that with HSA benefits, which I’ll cover next.
HSA Benefits You Should Know
An HSA is another important but often overlooked tax-advantaged account. It gives you the following tax benefits when you use funds to pay for qualified, unreimbursed medical expenses:
- Your contributions are never taxed.
- Your account earnings are never taxed.
- Your withdrawals are never taxed.
This triple tax advantage makes an HSA more valuable than other tax-advantaged accounts — such an IRA, 401k or 529 college savings plan — which only have double tax advantages.
Just like with retirement accounts, you can choose from a menu of diversified investing funds for additional growth in your HSA. But there are no income requirements or limits to qualify.
There’s no HSA spending deadline or requirement to make contributions, but there are annual caps. For 2019, you can contribute up to $3,500 if you have insurance for just yourself, or up to $7,000 if you have a family plan.
These HSA contribution limits are up $50 and $100, respectively, from 2018. If you’re over age 55, you can also contribute an additional $1,000.
See: Why You Need an HSA
I love using my HSA to pay for eligible medical, dental and vision expenses completely tax-free. It makes these typically expensive services much more affordable.
But here’s the kicker: If you still have funds in an HSA after you turn 65, it morphs into something very similar to a traditional retirement account, but without any mandatory withdrawals. You can use HSA distributions for non-medical expenses without any penalty, but you still must pay income tax on withdrawals.
HSA Limitations You Should Know
While the benefits of an HSA are amazing, not everyone can cash in. You can only have an HSA when you also have a type of insurance known as a high-deductible health plan, which requires you to pay more out of pocket before your insurance coverage begins.
If you’re in relatively good health, a high-deductible health plan paired with an HSA can be a clever way to cut healthcare costs and boost your retirement savings at the same time.
Click through to read more about seven common reasons people don’t save for retirement.
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This article originally appeared on GOBankingRates.com: Why I’d Rather Save for Retirement Using an HSA Than an IRA