Healthcare costs are only going up. People are living longer, health care inflation continues to exceed the rate of general inflation, and the average retirement age is 62 for most Americans, which is 3 years earlier than Medicare eligibility. These reasons along with several others make it crucial for those preparing for retirement to act today to help prevent health care costs from eroding their retirement nest egg and having a negative impact on their lifestyle. The Health Savings Account (HSA) is one tool that can help do just that.
What is a Health Savings Account (HSA)?
HSA’s are tax-advantaged savings and investment accounts that work with high-deductible health insurance plans to allow employees to save for their out-of-pocket medical expenses. Contributions are tax-deductible, withdrawals for qualified health-care expenses are tax-free, and funds remain in your account from year to year since you aren’t required to spend it within any specific time frame. This allows you the ability to bankroll funds to use during your retirement years to pay for health-care expenses.
To qualify for an HSA, you must have a qualifying high-deductible health plan. According to the IRS publication 969, for 2019, this means a health insurance plan with a minimum deductible of $1,350 for individual coverage or $2,700 for family coverage. Your plan also needs to meet an out-of-pocket maximum of $6,750 for individual coverage or $13,500 for family coverage.
How Much Can You Contribute?
According to the IRS, contribution limits for 2019 are $3,500 for individual coverage and $7,000 for family coverage. Contributions can be made until the April tax deadline. Also, important to note is for those age 55 and older, an additional contribution of $1,000 can be made.
If you’re lucky enough that your employer makes HSA contributions to your account on your behalf, these contributions are included in your annual limit. So, if you have family coverage with a $7,000 contribution limit and your employer gives $1,000 to your HSA account, you can only contribute the difference of $6,000. According to an article released by Fidelity, in 2017, 21% of all HSA contributions made to an HSA account came from an employer. Many employers will deposit their full annual contribution into their employee’s accounts at the beginning of the year or at the time of enrollment in the HSA health plan. So, ask questions and gain an understanding of what your employer offers.
What are the Main Benefits of an HSA?
- Contributions are tax-deductible up to your annual maximum. Should you contribute the maximum to your HSA, you will lower your taxable income.
- Money inside your HSA grows tax-deferred, which means you don’t have to pay annual taxes on capital gains, interest income or dividends that take place within the account.
- Withdrawals used to pay for qualified health-care expenses are completely tax-free.
- Once you reach age 65, you can withdraw money from your HSA for any reason, not just medical-related reasons without penalty (if you do withdraw for non-qualified medical expenses, it will be treated as taxable income). It is important to mention if you are younger than age 65, and you withdraw from your HAS account, you will face a 20% early withdrawal penalty in addition to any income tax you will have to pay on the money.
- Once you reach retirement age, there are no required minimum distributions (RMDs) to worry about after age 70 ½.
- Many employers offer a company contribution to employee’s HSA accounts thereby helping the accounts grow even more.
- Balances can be carried over year to year. There is no specified time frame in which you must use the funds. This enables you to grow the account substantially leading up to retirement.
- You can choose to invest the funds inside your HSA account as you would do for a 401(k) account.
- Some people are not eligible to make Roth IRA contributions or to deduct their contributions to a traditional IRA income limits do not apply to HSAs.
Creative Ways to Use Your HSA in Retirement
Pay for Medicare Premiums
An HSA can be used to pay certain Medicare expenses. This includes premiums for Part B and Part D prescription drug coverage (not supplemental Medigap premiums).
Close the Gap to Medicare
For those who decide to retire prior to age 65, you more than likely will need health care coverage to help you close the gap to your Medicare-eligible age of 65. HSAs can pay for health care coverage purchased through an employer-sponsored plan through COBRA or if you lose your job and are receiving unemployment, your HSA can pay the health insurance premiums. However, these are two exceptions and typically these accounts can not be used to pay private health insurance premiums.
Long-term Care Expenses
Part of the cost for a “tax-qualified” long-term care insurance policy can be covered by an HSA. The amount you can use increases as you get older.
Pay for typical daily expenses
Since there is no penalty for using the funds in an HSA account for expenses other than health care once you are older than age 65, you can use the money to cover any expenses you wish, but you will have to pay income tax.
Use it Simply as Your Health Expense Nest Egg During Retirement
Due to the amazing tax advantages and carry over feature associated with HSA accounts, you can create a sizeable savings over time leading up to retirement, which can serve as your earmarked account to cover these costs, which Fidelity estimates are about $280,000 for a couple during their retirement years.
What can You Use HSA Funds for?
The IRS provides a comprehensive list of expenses that qualify for HSA distributions within publication 969. Some of the most commonly covered expenses are:
- Prescription drugs
- Dental care
- Vision care
- Long-term care
- Medical equipment
The cost of medical expenses continues to rise. HSAs serve as an excellent option to accumulate money tax-deferred money for medical expenses that can be withdrawn tax-free in retirement. Its carryover feature and the ability to invest funds make this a valid retirement planning tool and long-term investment vehicle for many. The savings it can offer on your health-care costs in retirement, as well as the savings it can offer on your tax bill, make HSAs a hard option to ignore.
Sources: Motley Fool/ USA Today/ Fidelity/ IRS
© Geier Asset Management, Inc. July 2019. Thomas M. Geier, CPA, CFP ®, PFA is a Vice President of Geier Asset Management, Inc., a Registered Investment Advisor. The articles & opinions expressed in this material were gathered from a variety of sources, but are reviewed by Geier Asset Management, Inc. prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of July 2019 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual circumstances. In all cases, please contact your investment professional before making any investment choices. Geier Asset Management, Inc. is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.