Retirement Uses for Your Health Savings Account (HSA)

You know a health savings account (HSA) helps pay for out-of-pocket medical prices, however it could shock you to study that this tax-advantaged account could possibly be a superior retirement financial savings automobile, too. It has develop into ingrained in us that we must always max out our 401(ok) or different office outlined contribution plan as one of the simplest ways to save lots of for retirement. This is definitely good recommendation. But ought to these health-cost financial savings plans even be maxed out in comparable vogue? Here is a have a look at what these accounts are, who can open one, and how you can make the most effective use of an HSA for your retirement in case you are lucky sufficient to have one.

What Is a Health Savings Account (HSA)?

HSAs are tax-advantaged financial savings accounts designed to assist individuals who have high-deductible health plans (HDHPs) pay for out-of-pocket medical bills. While these accounts have been accessible since 2004, too few eligible Americans are making the most of them.

According to an Oct. 2018 report from the Employee Benefit Research Institute (EBRI), about 21.4 million to 33.7 million individuals had HSA-eligible medical health insurance plans in 2017, however solely 22.2 million of that quantity had opened an HSA. An April 2018 survey by America’s Health Insurance Plans (AHIP) of its member insurers reported 21.8 million HSA enrollees in 52 HDHP plans in 2017, up from 20.2 million the earlier 12 months. These forms of well being plans are provided by about 43% of employers proper now.

Moreover, in a later report, the EBRI famous that folks with HSAs had a median stability of simply $2,922 in 2016—a pittance, contemplating that the allowable annual contribution in 2020 is $3,550 (rising to $3,600 in 2021) for these with particular person well being plans and $7,100 for these with household protection (rising to $7,200 in 2021).

In addition, solely 6% of HSAs had been in funding accounts. EBRI discovered that nearly nobody contributes the utmost, and almost everybody takes present distributions to pay for medical expenses.

All of which means customers who’ve HSAs—in addition to customers who’re eligible for HSAs however haven’t opened one—are lacking out on an unimaginable possibility for funding their later years. It’s time to start out a brand new pattern.

Why Use an HSA for Retirement?

An HSA’s triple tax benefit, which is analogous to that of a conventional 401(ok) plan or IRA, makes it a top-notch technique to save for retirement. HSAs are “the most tax-preferred account available,” writes Michael Kitces, director of economic planning at Pinnacle Advisory Group Inc. in Columbia, Md. “Using one to save for retirement medical expenses is a better strategy than using retirement accounts.”

Benefits of an HSA

Your contributions to an HSA might be made through payroll deductions, in addition to from your individual funds. If the latter, they’re tax-deductible, even if you happen to do not itemize. If they’re constructed from your individual funds, they’re thought-about to be made on a pre-tax foundation, which means that they scale back your federal and state earnings tax liability—they usually’re not topic to FICA taxes, both.

Your account stability grows tax-free. Any curiosity, dividends, or capital positive aspects you earn are nontaxable.

Withdrawals for certified medical bills are tax-free. This is a key approach through which an HSA is superior to a conventional 401(ok) or IRA as a retirement automobile. Once you start to withdraw funds from these plans, you pay earnings tax on that cash, no matter how the funds are getting used.

Unlike a 401(ok) or IRA, an HSA doesn’t require the account-holder to start withdrawing funds at a sure age. The account can stay untouched so long as you want, though you’re not allowed to contribute when you enroll in Medicare. You develop into eligible for Medicare at age 65 and shall be routinely enrolled in Parts A and B in case you are already receiving Social Security.

What’s extra, the stability might be carried over from 12 months to 12 months; you aren’t legally obligated to “use it or lose it,” as with a flexible spending account (FSA). An HSA can transfer with you to a brand new job, too. You personal the account, not your employer, which suggests the account is absolutely moveable and goes when and the place you do.

Who Can Open an HSA?

To qualify for an HSA, it’s essential to have a high-deductible well being plan and no different medical health insurance. You should not but qualify for Medicare, and also you can’t be claimed as a depending on another person’s tax return.

A main concern many customers have about foregoing a preferred provider organization (PPO), health maintenance organization (HMO) plan, or different medical health insurance in favor of a high-deductible well being plan is that they will be unable to afford their medical bills.

In 2020, the deductible for an HDHP is not less than $1,400 for self-only protection and $2,800 for household protection (they continue to be the identical in 2021). Depending in your protection, your annual out-of-pocket bills in 2020 might run as excessive as $6,900 for particular person protection—or $13,800 for household protection—beneath an HDHP (rising to $7,000 and $14,000, respectively, in 2021).   High bills might be one cause these plans are extra in style amongst prosperous households who will profit from the tax benefits and may afford the chance.

However, based on Fidelity, a lower-deductible plan corresponding to a PPO could possibly be costing you greater than $2,000 a 12 months in increased premiums since you’re paying the additional cash whatever the measurement of your medical bills that 12 months. With an HDHP, in contrast, you are spending extra carefully matches your precise healthcare wants.

Of course, if you understand your healthcare prices are prone to be excessive—a lady who’s pregnant, for occasion, or somebody with a power medical situation—a well being plan with a excessive deductible is probably not your best option for you. But understand that HDHPs fully cowl some preventive care services earlier than you meet your deductible.

All in all, an HDHP is likely to be extra budget-friendly than you suppose—particularly when you think about its benefits for retirement. Let’s check out how you could possibly be utilizing the options of an HSA to extra simply and extra robustly fund your retirement.

Max Out Contributions by Age 65

As talked about above, your HSA contributions are tax-deductible till you enroll for Medicare. The contribution limits of $3,550 (self-only protection) and $7,100 (household protection) embrace employer contributions. The contributions limits are adjusted yearly for inflation.

If you’ve got an HSA and also you’re 55 or older, you can also make an additional “catch-up” contribution of $1,000 per 12 months and a partner who’s 55 or older can do the identical, supplied every of you has your individual HSA account.

You can contribute as much as the utmost no matter your earnings, and your complete contribution is tax-deductible. You may even contribute in years when you haven’t any earnings. You may also contribute if you happen to’re self-employed.

“Maxing out contributions before age 65 allows you to save for general retirement expenses beyond medical expenses,” says Mark Hebner, founder and president of Index Fund Advisors Inc. in Irvine, Calif., and writer of “Index Funds: The 12-Step Recovery Program for Active Investors.”

“Although you will not receive the tax exemption,” Hebner provides, “it gives retirees more access to more resources to fund general living expenses.”

Don’t Spend Your Contributions

This could sound counterintuitive, however we’re an HSA primarily as an funding instrument. Granted, the fundamental concept behind an HSA is to provide individuals with a high-deductible well being plan a tax break to make their out-of-pocket medical bills extra manageable.

But that triple tax benefit implies that the best way to use an HSA is to deal with it as an funding instrument that can enhance your monetary image in retirement. And one of the simplest ways to try this is to by no means spend your HSA contributions throughout your working years and pay money out of pocket for your medical payments.

In different phrases, consider your HSA contributions the identical approach you consider your contributions to every other retirement account: untouchable till you retire. Remember, the IRS doesn’t require you to take distributions out of your HSA in any 12 months, earlier than or throughout retirement. 

If you completely should spend a few of your contributions earlier than retirement, make sure to spend them on certified medical bills. These distributions will not be taxable. If you’re compelled to spend the cash on anything earlier than you’re 65, you’ll pay a 20% penalty and additionally, you will pay earnings tax on these funds. 

Invest Your Contributions Wisely

The key to maximizing your unspent contributions, after all, is to take a position them correctly. Your investment strategy needs to be just like the one you’re utilizing for your different retirement belongings, corresponding to a 401(ok) plan or an IRA. When deciding how you can make investments your HSA belongings, be sure that to think about your portfolio as a complete in order that your general diversification technique and risk profile are the place you need them to be.

Your employer would possibly make it simple for you to open an HSA with a specific administrator, however the selection of the place to place your cash is yours. An HSA will not be as restrictive as a 401(ok); it’s extra like an IRA. Since some directors solely allow you to put your cash in a financial savings account, the place you’ll barely earn any curiosity, be sure that to buy round for a plan with high-quality, low-cost funding choices, corresponding to Vanguard or Fidelity funds. 

How Much Could You Receive?

Let’s do some simple arithmetic to see how handsomely this HSA financial savings and funding technique can repay. We’ll use one thing near a best-case state of affairs and say that you just’re at present 21, you make the utmost allowable contribution yearly to a self-only plan, and also you contribute yearly till you’re 65. We’ll assume that you just make investments all of your contributions and routinely reinvest all of your returns within the inventory market, incomes a median annual return of 8% and that your plan has no charges. By retirement, your HSA would have greater than $1.2 million.

What a couple of extra conservative estimate? Suppose you’re now 40 years outdated and also you solely put in $100 per 30 days till you’re 65, incomes a median annual return of three%. You’d nonetheless find yourself with almost $45,000 by retirement. Try out an online HSA calculator to play with the numbers for your individual scenario. 

Maximize Your HSA Assets

Here are some choices for utilizing your accrued HSA contributions and funding returns in retirement. Remember, distributions for certified medical bills will not be taxable, so that you wish to use the cash completely for these bills if doable. There are not any required minimum distributions, so you possibly can hold the cash invested till you want it.

If you do want to make use of the distributions for one other goal, they are going to be taxable. However, after age 65, you gained’t owe the 20% penalty. Using HSA belongings for functions apart from certified medical bills is usually much less detrimental to your funds when you’ve reached retirement age as a result of it’s possible you’ll be in a decrease tax bracket if you happen to’ve stopped working, lowered your hours, or modified jobs.

In this fashion, an HSA is successfully the identical as a 401(ok) or every other retirement account, with one key distinction: There isn’t any requirement to start withdrawing the cash at age 72. So you don’t have to fret about saving an excessive amount of in your HSA and never with the ability to use all of it successfully.

Timing Is Everything

By ready so long as doable to spend your HSA belongings, you maximize your potential funding returns and provides your self as a lot cash as doable to work with. You’ll additionally wish to contemplate market fluctuations when taking distributions, the identical approach you’ll when taking distributions from an funding account. You clearly wish to keep away from promoting investments at a loss to pay for medical bills.

Choose a Beneficiary

When you open your HSA, you can be requested to designate a beneficiary to whom any funds nonetheless within the account ought to go upon your loss of life. If you are married, the most effective particular person to decide on is your partner as a result of they’ll inherit the stability tax-free. (As with any funding with a beneficiary, nevertheless, you must revisit your designations now and again as a result of loss of life, divorce, or different life adjustments could alter your decisions.) 

Anyone else you allow your HSA to shall be topic to tax on the plan’s fair market value after they inherit it. Your plan administrator can have a designation-of-beneficiary kind you possibly can fill out to formalize your selection.

Pay Health Expenses in Retirement

Fidelity Investments’ most up-to-date Retirement Health Care Cost survey calculates that the cost of healthcare throughout retirement for a pair who each flip 65 in 2020 is $295,000, up from $285,000 in 2019. Funds captured in an HSA may help out with such skyrocketing prices.

Qualified funds for which tax-free HSA withdrawals might be made embrace:

• Office-visit copayments
• Health insurance coverage deductibles
• Dental bills
• Vision care (eye exams and eyeglasses)
• Prescription medication and insulin
• Medicare premiums
• A portion of the premiums for a tax-qualified long-term care insurance coverage
• Hearing aids
• Hospital and bodily remedy payments
• Wheelchairs and walkers
• X-rays

You may also use your HSA stability to pay for in-home nursing care, retirement community charges for lifetime care, long-term care providers, nursing home charges, and meals and lodging which are mandatory whereas acquiring medical care away from dwelling. You may even use your HSA for modifications, corresponding to ramps, seize bars, and handrails, that make your property simpler to make use of as you age.

One technique is likely to be to bunch certified medical prices right into a single 12 months and faucet the HSA for tax-free funds to pay them, in contrast with withdrawing from different retirement accounts that might set off taxable earnings.

“Using HSA cash to pay for medical bills and long-term care insurance coverage in retirement is a good profit for buyers given the tax exemption on any withdrawals made to fund both,” says Hebner. “In different phrases, it’s essentially the most cost-effective technique to fund these bills as a result of they supply buyers the very best after-tax worth.” 

Also, be aware that there are limitations on how a lot you possibly can pay tax-free for long-term care insurance coverage based mostly in your age.

Reimburse Yourself for Expenses

With an HSA you aren’t required to take a distribution to reimburse your self in the identical 12 months you incur a specific medical expense. The key limitation is you can’t use an HSA stability to reimburse your self for medical bills you incurred earlier than you established the account.

So hold your receipts for all healthcare bills you pay out of pocket after you identify your HSA. If, in your later years, you end up with more cash in your HSA than you understand what to do with, you should utilize your HSA stability to reimburse your self for these earlier bills.

Warnings About HSA Retirement Use

The methods described on this article are based mostly on federal tax legislation. Most states observe federal tax legislation relating to HSAs, however yours could not. As of the 2019 tax 12 months, California and New Jersey tax HSA contributions. Even if you happen to reside in a state that taxes HSAs, nevertheless, you’ll nonetheless get the federal tax advantages.

The taxation of those plans might change sooner or later at both the state or federal ranges. The plans might even be eradicated altogether, but when that occurs, we’d possible see them grandfathered for current account holders, as was the case with Archer MSAs.

The Bottom Line

A well being financial savings account, accessible to customers who select a high-deductible well being plan, has been largely neglected as an funding instrument, however with its triple tax benefit it gives a superb technique to save, make investments, and take distributions with out paying taxes.

The subsequent time you’re selecting a medical health insurance plan, take a better have a look at whether or not a high-deductible well being plan would possibly work for you. If so, open an HSA and begin contributing as quickly as you’re eligible. By maximizing your contributions, investing them, and leaving the stability untouched till retirement, you’ll generate a big addition to your different retirement choices.

Of course, you possibly can’t let the financial savings tail wag the medical canine. Hoarding your HSA monies relatively than attending to your well being is not beneficial. However, if you happen to’re financially in a position to make use of post-tax {dollars} for your present healthcare prices whereas saving your pre-tax HSA {dollars} for later, you could possibly construct a pleasant nest egg for your use in retirement.