Retirement Uses for Your Health Savings Account (HSA)
You know a health savings account (HSA) helps pay for out-of-pocket medical costs, but it may surprise you to learn that this tax-advantaged account could be a superior retirement savings vehicle, too. Here is a look at what these accounts are, who can open one, and how to make the best use of an HSA for your retirement if you are fortunate enough to have one.
- Health savings accounts can be good tools for funding retirement years.
- The high-deductible health plan you need to qualify for a health savings account (HSA) may be more budget-friendly than it seems because premiums are so low.
- Unlike a flexible spending account, your HSA money is yours forever, and it's portable.
- You can contribute to an HSA until you enroll in Medicare, even when you're not working.
- Save, don't spend your HSA funds—and your investment strategy should be similar to the one you’re using for your other retirement savings accounts.
What Is a Health Savings Account (HSA)?
HSAs are tax-advantaged savings accounts designed to help people who have high-deductible health plans (HDHPs) pay for out-of-pocket medical expenses. While these accounts have been available sincemany eligible Americans are not taking advantage of them.
These types of high-deductible health plans are offered by about 26% of employers who offer health benefits as of According to a March report from the Employee Benefit Research Institute (EBRI), anywhere from million to million people had HSA-eligible health insurance plans inbut only 11%% of those individuals had actually opened an account.
Moreover, people with HSAs had an average balance of just $3, in —a pittance, considering that the allowable health savings account rules retirement contribution in is $3, (rising to $3, in ) for those with individual health plans and $7, for those with family coverage (increasing to $7, in ).
In addition, only 7% of HSAs were in investment accounts other than cash, as of EBRI found that virtually no one contributes the maximum, and nearly everyone takes current distributions to pay for medical expenses.
All of this means that consumers who have HSAs—as well as consumers who are eligible for HSAs but haven’t opened one—are missing out on an incredible option for funding their later years. It’s time to start a new trend.
Why Use an HSA for Retirement?
An HSA's triple tax advantage, which is similar to that of a traditional (k) plan or IRA, makes it a top-notch way to save for retirement. HSAs are "the most tax-preferred account available," writes Michael Kitces, former director of financial 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 can be made via payroll deductions, as well as from your own funds. If the latter, they are tax-deductible, even if you don't itemize. If they're made from your own funds, they're considered to be made on a pre-tax basis, meaning they reduce your federal and state income tax liability—and they're not subject to FICA taxes, either.
Your account balance grows tax-free. Any interest, dividends, or capital gains you earn are nontaxable.
Any contributions your employer makes to your HSA do not have to be counted as part of your taxable income.
Withdrawals for qualified medical expenses are tax-free. This is a key way in which an HSA is superior to a traditional (k) or IRA as a retirement vehicle. Once you begin to withdraw funds from those plans, you pay income tax on that money, regardless of how the funds are being used.
Unlike a (k) or IRA, an HSA does not require the account holder to begin withdrawing funds at a certain age. The account can remain untouched as long as you like, although you are no longer allowed to contribute once you enroll in Medicare. You become eligible for Medicare at age
What's more, the balance can be carried over from year to year; you are not legally obligated to "use it or lose it," as with a flexible spending account (FSA). An HSA can move with you to a new job, too. You own the account, not your employer, which means the account is fully portable and goes when and where you do.
Who Can Open an HSA?
To qualify for an HSA, you must have a high-deductible health plan and no other health insurance. You must not yet qualify for Medicare, and you cannot be claimed as a dependent on someone else's tax return.
A primary concern many consumers have about foregoing a preferred provider organization (PPO), health maintenance organization (HMO) plan, or other health insurance in favor of a high-deductible health plan is that they will not be able to afford their medical expenses.
Inthe deductible for an HDHP is at least $1, for self-only coverage and $2, for family coverage (they remain the same in ). Depending on your coverage, your annual out-of-pocket expenses could run as highas $7, for individual coverage—or $14, for family coverage—under an HDHP (increasing to $7, and $14, respectively, in ). High expenses can be one reason these amazon kindle seller account login are more popular among affluent families who will benefit from the tax advantages and can afford the risk.
However, a lower-deductible plan such as a PPO could have high costs because you’re paying the extra money regardless of the size of your medical expenses that year. With an HDHP, by contrast, you're spending more closely matches your actual healthcare needs.
Of course, if you know your healthcare costs are likely to be high—a woman who is pregnant, for instance, or someone with a chronic medical condition—a health plan with a high deductible may not be the best choice for you. But keep in mind that HDHPs completely cover some preventive care services before you meet your deductible.
All in all, an HDHP might be more budget-friendly than you think—especially when you consider its advantages for retirement. Let’s take a look at how you could be using the features of an HSA to more easily and more robustly fund your retirement.
Max Out Contributions by Age 65
As mentioned above, your HSA contributions are tax-deductible until you sign up for Medicare. The contribution limits of $3, (self-only coverage) and $7, (family coverage) include employer contributions. The contribution limits are adjusted annually for inflation.
The contribution limit for a family health savings account in The contribution limit for a self-only (individual) HSA is $3,
If you have an HSA and you're 55 or older, you can make an extra "catch-up" contribution of $1, per year and a spouse who is 55 or older can do the same, provided each of you has your own HSA account.
You can contribute up to the maximum regardless of your income, and your entire contribution is tax-deductible. You can even contribute in years when you have no income. You can also contribute if you'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 author of Index Funds: The Step Recovery Program for Active Investors.
"Although you will not receive the tax exemption," Hebner adds, "it gives retirees more access to more resources to fund general living expenses."
Don't Spend Your Contributions
This may sound counterintuitive, but we're looking at an HSA primarily as an investment tool. Granted, the basic idea behind an HSA is to give people with a high-deductible health plan a tax break to make their out-of-pocket medical expenses more manageable.
But that triple tax advantage means that the best way to use an HSA is to treat it as an investment tool that will improve your financial picture in retirement. And the best way to do that is to never spend your HSA contributions during your working years and pay cash out of pocket for your medical bills.
In other words, think of your HSA contributions the same way you think of your contributions to any other retirement account: untouchable until you retire. Remember, the IRS does not require you to take distributions from your HSA in any year, before or during retirement.
If you absolutely must spend some of your contributions before retirement, be sure to spend them on qualified medical expenses. These distributions are not taxable. If you are forced to spend the money on anything else before you’re 65, you will pay a 20% penalty and you will also pay income tax on those funds.
Invest Your Contributions Wisely
The key to maximizing your unspent contributions, of course, is to invest them wisely. Your investment strategy should be similar to the one you’re using for your other retirement assets, such as a (k) plan or an IRA. When deciding how to invest your HSA assets, make sure to consider your portfolio as a whole so your overall diversification strategy and risk profile are where you want them to be.
Your employer might make it easy for you to open an HSA with a particular administrator, but the choice of where to put your money is yours. An HSA is not as restrictive as a (k); it’s more like an IRA. Since some administrators only let you put your money in a savings account, where you’ll barely earn any interest, make sure to shop around for a plan with high-quality, low-cost investment options, such as Vanguard or Fidelity funds.
How Much Could You Receive?
Let's do some simple math to see how handsomely this HSA savings and investment strategy can pay off. We’ll use something close to a best-case scenario and say that you’re currently 21, you make the maximum allowable contribution every year to a self-only plan, and you contribute every year until you’re We’ll assume that you invest all your contributions, automatically reinvest all your returns in the stock market, earning an average annual return of 8%, and that your plan has no fees. By retirement, your HSA would have more than $ million.
What about a more conservative estimate? Suppose you’re now 40 years old and you only put in $ per month until you’re 65, earning an average annual return of 3%. You’d still end up with nearly $45, by retirement. Try out an online HSA calculator to play with the numbers for your own situation.
Maximize Your HSA Assets
Here are some options for using your accumulated HSA contributions and investment returns in retirement. Remember, distributions for qualified medical expenses are not taxable, so you want to use the money exclusively for those expenses if possible. There are no required minimum distributions, so you can keep the money invested until you need it.
If you do need to use the distributions for another purpose, they will be taxable. However, after age 65, you won’t owe the 20% penalty. Using HSA assets for purposes other than qualified medical expenses is generally less detrimental to your finances once you’ve reached retirement age because you may be in a lower tax bracket if you’ve stopped working, reduced your hours, or changed jobs.
In this way, an HSA is effectively the same as a (k) or any other retirement account, with one key difference: There is no requirement to begin withdrawing the money at age So you don’t have to worry about saving too much in your HSA and not being able to use it all effectively.
Timing Is Everything
By waiting as long as possible to spend your HSA assets, you maximize your potential investment returns and give yourself as much money as possible to work with. You’ll also want to consider market fluctuations when taking distributions, the same way you would when taking distributions from an investment account. You obviously want to avoid selling investments at a loss to pay for medical expenses.
Choose a Beneficiary
When you open your HSA, you will be asked to designate a beneficiary to whom any funds still in the account should go upon your death. If you're married, the best person to choose is your spouse because they can inherit the balance tax-free. (As with any investment with a beneficiary, however, you should revisit your designations from time to time because death, divorce, or other life changes may alter your choices.)
Anyone else you leave your HSA to will be subject to tax on the plan’s fair market value when they inherit it. Your plan administrator will have a designation-of-beneficiary form you can fill out to formalize your choice.
Pay Health Expenses in Retirement
Fidelity Investments’ most recent Retirement Health Care Cost survey calculates that the cost of healthcare throughout retirement for a couple who both turn 65 in is $, up from $, in and $, in Funds captured in an HSA can help out with such skyrocketing costs.
Qualified payments for which tax-free HSA withdrawals can be made include:
- Office-visit copayments
- Health insurance deductibles
- Dental expenses
- Vision care (eye exams and eyeglasses)
- Prescription drugs and insulin
- Medicare premiums
- A portion of the premiums for a tax-qualified long-term care insurance policy
- Hearing aids
- Hospital and physical therapy bills
- Wheelchairs and walkers
You can also use your HSA balance to pay for in-home nursing care, retirement community fees for lifetime care, long-term care services, nursing home fees, and meals and lodging that are necessary while obtaining medical care away from home. You can even use your HSA for modifications, such as ramps, grab bars, and handrails, that make your home easier to use as you age.
One strategy might be to bunch qualified medical costs into a single year and tap the HSA for tax-free funds to pay them, compared with withdrawing from other retirement accounts that would trigger taxable income.
“Using HSA money to pay for medical expenses and long-term care insurance in retirement is a great benefit for investors given the tax exemption on any withdrawals made to fund either," says Hebner. "In other words, it’s the most cost-effective way to fund those expenses because they provide investors the highest after-tax value."
Also, note that there are limitations on how much you can pay tax-free for long-term care insurance based on your age.
Reimburse Yourself for Expenses
With an HSA you are not required to take a distribution to reimburse yourself in the same year you incur a particular medical expense. The key limitation is that you can’t use an HSA balance to reimburse yourself for medical expenses you incurred before you established the account.
So keep your receipts for all healthcare expenses you pay out of pocket after you establish your HSA. If in your later years, you find yourself with more money in your HSA than you know what to do with, you can use your HSA balance to reimburse yourself for those earlier expenses.
Warnings About HSA Retirement Use
The strategies described in this article are based on federal tax law. Most states follow federal tax law when it comes to HSAs, but yours may not. As of the tax year, California taxes HSA contributions. Even if you live in a state that taxes HSAs, however, you’ll still get the federal tax benefits.
The taxation of these plans could change in the future at either the state or federal levels. The plans could even be eliminated altogether, but if that happens, we would likely see the existing account holders exempted, as was the case with Archer MSAs.
The Bottom Line
A health savings account, available to consumers who choose a high-deductible health plan, has been largely overlooked as an investment tool, but with its triple tax advantage, it provides an excellent way to save, invest, and take distributions without paying taxes.
The next time you’re choosing a health insurance plan, take a closer look at whether a high-deductible health plan might work for you. If so, open an HSA and start contributing as soon as you’re eligible. By maximizing your contributions, investing them, and leaving the balance untouched until retirement, you’ll generate a significant addition to your other retirement options.
Of course, you can't let the savings tail wag the medical dog. Hoarding your HSA monies rather than attending to your health is not recommended. However, if you’re financially able to use post-tax dollars for your current healthcare costs while saving your pre-tax HSA dollars for later, you could build a nice nest egg for your use in retirement.
Health Savings Account Rules for Retirees
My wife and I turn 65 this year and will sign up for Medicare. Will we still be able to use the money in our health savings account?
You sure can. Even though you can't contribute to an HSA after you sign up for Medicare, you can keep the account and use the money tax-free for medical expenses. In fact, you can use the money in the HSA for anything after age 65, although you will owe taxes on any withdrawals you make for nonmedical expenses.
There are plenty of medical expenses to which you can apply the money. For example, you can tap the account for Medicare deductibles and co-payments. You may also be able to use HSA money to cover premiums for Medicare parts A, B and D (prescription-drug coverage), and to pay Medicare Advantage plan premiums. You may also use HSA money to help pay qualified long-term-care premiums. However, you can't use HSA money tax-free to pay medigap premiums.
For more information about health savings accounts, see Health Savings Account Answers. For more information about your health-insurance options after age 65, see Your Medicare Owner's Manual.
What is a health savings account? And why should I have one?
Health care is one of the biggest expenses you’ll have in retirement. So, putting money aside is very important. A few other reasons are:
- You can invest & potentially grow your money:
HSAs have investment options, too. This is a great way to potentially help pay for your health care costs in retirement – if you can afford to not use the money now. Invest and give your funds the opportunity to build until you’re ready to retire.
- You get triple tax benefits:
- Lower income taxes – potentially: Money going into your HSA comes out of your paycheck. So, your taxable income goes down, which means you could pay less in income taxes.
- Tax-free investment growth: You don’t pay taxes on your earnings.
- Tax-free withdrawals: You don’t pay taxes on your money as long as you spend it on qualifying health care costs.*
*HSAs are not taxed at a federal income tax level when used appropriately for qualified medical expenses. Also, most states, but not all, recognize HSA funds as tax-free. Please consult a health savings account rules retirement advisor regarding your state’s specific rules.
Editorial Note: Credit Karma receives compensation from third-party advertisers, but that doesn’t affect our editors’ opinions. Our marketing partners don’t review, approve or endorse our editorial content. It’s accurate to the best of our knowledge when posted.
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Good health is beyond price, but maintaining it can be expensive.
Of course, health insurance helps. But health insurance typically doesn’t cover every single cost associated with maintaining your health. For example, you may have insurance that pays for an eye exam but not for eyeglasses, contact lenses or saline solution.
When you have health-related expenses that insurance doesn’t pay for, you may be able to cover those costs through a health savings account if you qualify to have one. Let’s look at how you can establish an HSA, the basics of health savings account rules, and some ways you can make an HSA work harder for you this year.Want help maximizing deductions? File My Taxes Now
A health savings account is a tax-exempt account you can set up with an HSA trustee, provided you’re eligible to have one. You can use the money in an HSA to pay for qualified medical expenses.
You could be eligible to contribute to an HSA if youre covered by a health insurance plan classified as a high deductible health plan (HDHP). You cant be enrolled in Medicare, cant be claimed as a dependent on anyones tax return, and generally cant have insurance besides your HDHP (but there are some exceptions, such as a policy covering only a specific disease). Your employer may offer you an HSA, or you can open an HSA on your own as long as you qualify for one.
Most health insurance plans have some type of deductible — an amount you must pay for covered healthcare costs before the insurance begins to pay. HDHPs generally have a higher annual deductible than typical plans, and a maximum amount for the total of the deductible and out-of-pocket expenses (like co-payments) that you must pay for covered expenses in a year.
Foran insurance plan can be considered a high-deductible plan if the minimum annual deductible is $1, for self-only coverage or $2, for family coverage. Also, the maximum annual out-of-pocket expenses cannot be more than $6, for self-only coverage or $13, for family coverage in Forminimum annual deductibles are the same asbut out-of-pocket expenses limits increase slightly to $7, for self-only coverage and $14, for family coverage.
What medical expenses can you pay with an HSA?
Generally, you can use an HSA to pay for the same types of expenses that would be included in a medical and dental expense deduction (if you qualified to take one). These can include but aren’t limited to:
• Over-the-counter drugs your doctor prescribes for you
• Birth control pills
• Medical supplies such as bandages
• Dental visits and treatment
• Inpatient treatment for drug addiction
• Eye care such as exams, glasses and contact lenses (needed for medical reasons)
• The costs of buying, training and caring for guide dogs or other service animals that help people with vision, hearing or other physical disabilities
• Lab fees
• Special education for children with learning disabilities (with a doctor’s recommendation)
For a more comprehensive list, check out IRS Publication
If you meet the qualifying requirements for an HSA, you can contribute up to $3, for self-only plans and $7, for family plans in Inthe contribution limits rise to $3, for self-only coverage and $7, for family coverage. If you’ll be 55 or older at the end of either tax year, you may be able to make a catch-up contribution of an additional $1, to your HSA. Your employer may offer an HSA as an employment benefit and may contribute for you, in which case the total amount of your contributions and your employer’s can’t exceed the contribution limit.
Health savings accounts are fairly common. Inclose to three in 10 employees had a health savings account, and an estimated million to million insured policyholders and their dependents were enrolled in HSAs, according to the Employee Benefit Research Institute (ERBI).
The big tax advantages of HSAs
HSAs can offer significant tax advantages.
“Health savings accounts are treated in a tax favorable light by the IRS,” says Daniel Patterson, a certified financial planner with Sweetgrass Financial Planning in Mount Pleasant, South Carolina.
They are a “tax trifecta” because you can deduct the contributions you make (and don’t have to report employer contributions as income), any interest or other earnings the HSA gains aren’t taxed, and withdrawals may be tax free as long as they’re made for qualified medical expenses.
Plus, the money in your HSA remains yours even if you switch jobs or stop working.
Making your HSA work harder
If you’re wondering how to use your HSA to reap the maximum benefit from it, here are three basic tactics to consider:
- Maximizing your tax deduction
- Optimizing withdrawals
- Maximizing tax-free growth
Let’s look at ways to execute each tactic.
1. Maximize your tax deduction
Inonly 13% of people who had HSAs contributed the full amount they were permitted to contribute for the year, according to EBRI. If youre not contributing the full amount, youre not making the most of your HSA — one of the most generous types of tax breaks available.
Other tax-advantaged accounts, such as (k)s, offer less generous tax advantages. While traditional (k)s allow contributions with pre-tax funds, withdrawals are taxed. With Roth IRAs, the opposite is true; you contribute after-tax dollars but get tax-free growth and withdrawals.
With Walking the west highland way in 4 days, you can claim an income tax deduction on money going in and you won’t pay taxes on money coming out (provided withdrawals are for qualified medical expenses). Thats why Patterson describes HSAs as “one of the most tax-preferred vehicles around.”
Making the maximum allowed contribution gives you the highest possible deduction and allows more of your money to grow tax-free for future qualified use.
2. Optimize withdrawals
Three-fourths of HSAs that received contributions in also had distributions taken out that year. The average distribution amount was $1, according to ERBI.
Just because you can use your HSA dollars to pay for everyday healthcare expenses doesn’t necessarily mean you should. Remember, health savings account rules mean the longer your money stays in the HSA, the more interest and earnings it can gain — and grow toward helping you pay for bigger medical expenses when they occur.
“Even though the HSA is meant to help those in high-deductible plans pay for medical expenses, Id suggest paying your deductible out of pocket, if possible, so that you can allow your HSA account to continue to grow,” Patterson says. HSA balances roll over from year to year if funds arent used, so this tax-advantaged account can continue getting chase bank business promotions the extent possible, the HSA should be treated as a longer term or retirement account for medical expenses later in life,” says Josh Trubow, a certified financial planner and financial advisor with Sensible Financial Planning in Waltham, Health savings account rules retirement. “If you have other funds in a savings or checking account that are available, it may make sense to leave the HSA alone to accumulate tax free for use later.”
Healthcare costs can escalate in retirement. According to ERBI research, in a senior couple who retire by age 65 and whose drug costs are in the 90th percentile throughout retirement would need savings of $, to have a 90% chance of being able to cover healthcare expenses in retirement. Money in an HSA can help bolster retirement savings.
Health savings account rules allow seniors older than 65 to make withdrawals from an HSA without penalty, even if funds arent used for qualified medical expenses.
If you do need to use your HSA regularly for healthcare-related expenses, be sure you understand what’s a qualifying medical expense and what isn’t. If you accidentally use your HSA to pay for medical expenses that aren’t qualified, you’ll have to pay tax on the distribution amount. You may also be subject to an additional 20% tax on the distribution.Want help maximizing deductions? File My Taxes Now
3. Maximize tax-free growth
Injust 3% of HSAs had any money invested in assets other than cash, data from ERBI shows. This could be a missed opportunity if your HSA is the type that allows you to invest through your HSA.
If you can, Patterson suggests “invest[ing] your HSA like you would your (k) or IRA, and think of it as a long-term asset,” Patterson says. He advises developing a diversified portfolio appropriate for your life stage and risk tolerance.
“Investing some or all of the funds can help grow the account more than leaving the money in cash could,” Trubow agrees.
Trubow suggests investing as long as you dont plan to withdraw the money within the next year. “Investing the savings introduces risk to your account but gives you the potential for more upside.”
ERBI data from also indicates those who invested their HSAs in assets other than cash had much higher account balances than those who did not invest. This was true even though investors were more likely than non-investors to take distributions inalong with generally taking larger distributions.
If you participate in a qualified high-deductible health plan, an HSA can be an effective way to pay for medical costs not covered by insurance. It’s important to know health savings account rules and how HSAs work. HSAs offer tax benefits through tax-deductible contributions and tax-free growth and eligible distributions.
Finally, leaving your money in an HSA for as long as possible and investing your HSA funds wisely can help grow your money and save for retirement. In retirement, your income will likely be less and your health expenses greater, so that tax-advantaged HSA money can be even more valuable.Want help maximizing deductions? File My Taxes Now
Christina Taylor is senior manager of tax operations for Credit Karma Tax®. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.
About the author: Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher with experience writing textbo… Read more.
Why An HSA Should Be Part of Your Retirement Plan
Part of saving for retirement is creating a cushion to soften the blow of healthcare expenses that tend to grow as a person gets older. But (k)s and IRAs aren't the only way to save for your future. Health Savings Accounts are another great way to save for this major retirement expenseplus, they come with added tax benefits.
"It's a very good place to put retirement money as you prioritize savings accounts," says Andy Leung, a private wealth advisor with Procyon Partners in Connecticut.
Contributions to health savings accounts are made on either a pre-tax basis or are tax-deductible, depending on your employment situation. Earnings within the accounts and withdrawals for eligible healthcare expenses also are exempt from taxes. "It's triple tax savings," Leung says.
And if you're relatively healthy, money in an HSA can really add up over time.
How Your HSA Can Work For You
HSAs aren't intended as a replacement for other types of retirement accounts. They have lower annual contribution limits$3, for an individual and $7, for a family in than (k)s and IRAs and don't come with perks like employer matching.
But like retirement accounts, the balance in an HSA can be invested, allowing the funds to grow more quickly than they would even in a high interest rate savings account. Schwab and Fidelity, for example, allow customers to invest HSA money in stocks, bonds, mutual funds, Exchange Traded Funds and more. "An HSA can be invested in whatever that plan allows," Leung says.
Unlike Flexible Savings Accounts, whose balances have to be exhausted by the end of each year, money in an HSA doesn't have an expiration date. So you can say goodbye to that annual end-of-year FSA drugstore run to stock up on bandages, antacids, or menstrual products and hello to the power of compounding. Investing $2, in unused money through an HSA could add up to nearly $90, over 20 years, Fidelity estimates.
The Fine Print
While you can leave your money in an HSA for as long as you like, you can only fund an HSA when you have a high-deductible health insurance plan, defined by the IRS as any plan with an out-of-pocket deductible above $1, If you're shopping for insurance on the healthcare marketplace in your state, these tend to be bronze- and silver-level health insurance plans. You can take your HSA with you if you change health insurance, but your new first offender program virginia will determine whether you can make additional contributions to your HSA.
Keep in mind that if you are eligible to contribute to an HSA, you don't have to max it out. "You can incrementally increase your savings as your salary grows," says Amy Richardson, a certified financial planner with Schwab Intelligent Portfolios Premium.
And in retirement, that extra money could come in especially handy. Fidelity estimates healthcare adds up to about 15 percent of the average retiree's annual expenses. It recommends couples who are 65 or older budget about $, for medical expenses in retirement.
"Medical expenses are one health savings account rules retirement the biggest line items in retirement budgets," Richardson says.
Use Your Money When You Need It
Just because you can let the money in your HSA grow over time doesn't mean you should, especially if you're facing medical bills that are breaking your budget. "You don't want to not touch that and incur credit card debt," Richardson says.
Unlike (k)s and IRAs, you can withdraw money from an HSA without a financial penalty at any time as long as you use the funds for eligible healthcare expenses. That broad list of eligible expenses includes insurance premiums, prescriptions, medical procedures, and more. And best of all? Unlike a credit card, there's no interest to pay when tapping into your own HSA savings.
Supplemental Saving In An HSA For Retiree Medical Expenses
The Health Savings Account (HSA) is unique in the landscape of tax-preferenced investment acounts, as it is the only type that enjoys both the benefit of tax-deductible contributions and tax-free distributions (for medical expenses). In fact, the unique treatment of the HSA has created a wrinkle in the traditional approach of funding retirement accounts: given the inevitability of medical expenses in retirement, arguably the best savings account for retirement (or at least for a portion of retirement expenses) is to use a health savings account for retirement over “just” an IRA alone.
In other words, for any retiree that is saving for both medical expenses in retirement and also all of their other retirement goals, using a combination of an IRA (for most retirement expenses) supplemented by an HSA as a "retirement health savings account" may be the most tax-preferenced way to save holistically for retirement. In fact, the health savings account tax treatment is so good that it can even be superior to funding a (k) plan with a small match (for those who haven't already started a health savings account for retirement)!
Notably, this doesn’t mean that retirees would exclusively fund a health savings account for retirement, as the accounts are both taxable and potentially subject to penalties if used for non-medical purposes. But for those who already have some retirement accounts, and/or have more than enough dollars overall to achieve their goals, the fact remains that contributing the maximum to an HSA every year has the potential for more beneficial tax treatment than any other type of tax-preferenced account! Which makes accumulating in an HSA so desirable that it may even be preferable to pay current medical expenses out of pocket, just to preserve (and keep contributing to) the HSA account balance to be used as a future health retirement account!
Author: Michael Kitces
Michael Kitces is Head of Planning Strategy at Buckingham Wealth Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors.
In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website mynewextsetup.us, dedicated to advancing knowledge in financial planning. InMichael was recognized with one of the FPA’s “Heart of Health savings account rules retirement Planning” awards for his dedication and work in advancing the profession.
Health Savings Account Rules
The Health Savings Account (HSA) was created as a part of the Medicare Prescription Drug, Improvement, and Modernization Act of (also known as the Medicare Modernization Act).
The basic concept of the HSA is that it is a savings account to be used for health/medical expenses, with preferential tax treatment. Contributions to the Health Savings Account are pre-tax (either tax deductible if contributed directly, or excluded from income if contributed by an employer on behalf of an employee). Withdrawals from an HSA for qualified medical expenses are tax free (although non-qualified withdrawals are taxable as ordinary income plus a 20% penalty tax, with the penalty waived for those over age 65, or who are disabled, or if withdrawn as a non-spouse beneficiary after the death of the HSA owner).
Qualified medical expenses are generally any expenses that would otherwise be eligible for the medical (and dental) expenses deduction, along with any expenses paid for a doctor-prescribed drug. Qualified medical expenses also include insurance premiums for health insurance coverage health savings account rules retirement COBRA, health care coverage while receiving unemployment compensation, Medicare (but not Medigap) premiums, and even long-term care insurance (but only up to the age-based LTC premium limits).
In order to be eligible to participate in (i.e., to contribute to) a Health Savings Account, you must be covered under a High-Deductible Health Plan (HDHP), and not be enrolled in Medicare or other health coverage, nor claimed as a dependent on someone else’s tax return. A “high deductible” health plan must have a minimum deductible of $1, for self-only coverage or $2, for family coverage (in ), and can have a deductible as high as $6, for an individual or $13, for a family (in ).
Notably, while Health Savings Accounts were intended to help cover medical expenses associated with high-deductible health plans, the contribution limits to an HSA are set lower than the (maximum) limits on deductibles (though a health insurance plan may have a lower deductible to conform to the HSA limits). Inthe maximum contribution limit to an HSA is (only) $3, for an individual, or $6, for a family, plus a $1, “catch-up” contribution for those over age 55 (unlike retirement accounts, where catch-up contributions apply beginning at age 50).
What Happens If You Don’t Use Your HSA Right Away? Not A Use-It-Or-Lose-It Account!
Ultimately, the Health Savings Account is unique from the tax perspective, as it is one of the only accounts that permits both a tax deduction up front for contributions and can produce tax-free distributions for growth later – unlike retirement accounts, which may be pre-tax up front but taxable later (e.g., a traditional IRA or (k)), or are tax-free later but receive no tax deduction up front (e.g., a Roth IRA or (k)).
And despite this uniquely generous tax treatment for an HSA, there is actually no time limit on when funds in an HSA must be used. An HSA does not have a “use it or lose it” provision like the Flexible Spending Account (FSA) where anything more than $ of unused funds are forfeited at the end of the year. Instead, as long as they were permitted to be contributed into the HSA in the first place (i.e., the HSA owner was covered under an HDHP at the time), HSA funds can remain in the account for an extended period of time (growing on a tax-deferred basis) and be used (tax-free) later.
In turn, the only requirement at the time of distribution for tax-free treatment from an HSA is that the withdrawal either cover a current medical expense, or be used to reimburse a prior one (that was itself paid out of pocket, was not reimbursed from another source, and was not previously claimed as an itemized deduction). This means that medical expenses can occur now and be reimbursed later (even far later) in the future and still be qualified, as long as documentation of the medical expense is maintained and as long as the medical expense occurred after the HSA was originally established. Alternatively, this means that funds can be contributed now to an HSA, and grow tax-free for years or even decades, before being used (tax-free including all those years of growth) for a distant future medical expense.
Even further extending the favorable deferral period for an HSA, the rules stipulate that if the HSA is not used before death, a surviving spouse can continue the HSA in his/her own name and continue the preferential tax treatment (including future tax-free withdrawals). This form of HSA spousal rollover is similar to that permitted for retirement accounts.
A Supplemental Retirement Vehicle - The Retirement Health Savings Account (HSA)
What Can You Use Your Health Savings Account For?
The classic view of an HSA is that it’s an account to hold the money that someone sets aside to cover the deductible for their health insurance. Funds are contributed to the account on a pre-tax basis, and to the extent they’re subsequently used (typically that year) to cover the unreimbursed expenses associated with the health plan’s deductible, the end result is that health expenses are paid on a pre-tax basis (with the HSA as the ‘conduit’ to make that happen). This is often a better tax treatment than paying health care expenses directly from a checking account, where payments are just "normal" medical expenses with a deduction limited to 10% of Adjusted Gross Income (AGI) for those under age which means most or all medical expenses paid out of pocket don’t actually produce a tax benefit.
In addition, to the extent that not all the funds for the HSA are actually used on medical expenses for the current year – for instance, the account owner didn’t actually incur enough medical expenses to use the funds in the first place – the remaining account balance simply “carries over” to be used in a subsequent year.
Other Health Savings Account Uses
Because there’s no requirement that HSA funds be used to cover medical expenses in the current year – the HSA can be used in the future – an alternative opportunity emerges: to contribute funds to an HSA, and deliberately not use them as medical expenses are incurred. Instead, medical expenses are paid out of pocket – in addition to the HSA contribution – and the HSA funds are allowed to accrue (tax-free) for future use instead.
Of course, the caveat to this approach is that it’s only helpful if the funds really can be used in the future on a tax-free basis. If it turns out they have to be withdrawn as a non-qualified distribution, the inhospitable taxes plus 20% penalty will apply. Yet the reality is that for a future retiree, the odds are overwhelming that some medical expenses really will be applicable in retirement. In fact, “typical” retiree expenses on health care are often as much as $/month (or $1,/month for a married couple), much of which covers HSA-eligible qualified medical expenses like Medicare premiums and out-of-pocket medical costs (although Medigap coverage doesn’t count). Cumulatively, Fidelity’s annual “Health Care Cost Estimate” study for retirees estimates that a year-old couple will need a whopping $, to cover health care expenses in retirement.
In other words, if we think of expenses in retirement as including both medical norton antivirus chat customer service “other” retirement expenses (where “other” includes housing, entertainment, food, lifestyle, and everything else that isn’t medical), then an HSA can be used to save for the medical portion of retirement expenses, and retirement accounts can be used for all other retirement expenses. In fact, with the virtual certainty of ongoing Medicare premiums along, contributing to an HSA now is effectively a form of Medicare Health Savings Account, allowing tax-free growth for future Medicare expenses. Which ultimately is a better strategy than “just” using retirement accounts for retirement, given that the HSA has better tax treatment (pre-tax going in and tax-free coming out) than any type of retirement account (which only gets the tax-deduction up front or tax-free distributions, but not both).
Paying Medical Expenses Out Of Pocket To Defer HSA Distributions For Medicare Premiums
Given that eligibility to contribute to an HSA starts with being a participant in a high-deductible health plan – which means if a health event happens, there will be significant out-of-pocket medical expenses to cover – the strategy of using an HSA as an accumulation vehicle to supplement retirement effectively means having a high-deductible health plan, funding the HSA, and then not using the HSA for the inevitable health care expenses that occur.
This can place a non-trivial cash flow burden on the household, as it means it’s necessary to have far more cash on hand – enough to cover the pre-tax contribution to the HSA (as much as $3, for an individual and $6, for the family), plus the health plan’s actual deductible (which could be as high as $6, for an individual and $13, for a family! And as noted earlier, most of that health insurance deductible will not likely be tax deductible, either. In other words, the household’s cash flow commitment to health care expenses may be increased by upwards of 50% over what might have been set aside for “just” the health insurance deductible alone.
Nonetheless, to the extent that a household really does have more-than-enough to cover the health insurance deductible, the reality is those excess funds were going to be saved somewhere anyway. So the real question is whether to contribute to the HSA and use it for medical expenses (and then save the rest elsewhere), or to contribute to the HSA and use other funds for medical expenses instead. With the potential that by contributing to the HSA and using other funds for medical expenses, the HSA can grow (tax-free) until retirement and then be used to cover Medicare premiums and other retiree health care expenses.
Paying Non-Deductible Medical Expenses Out Of Pocket While Growing A Health Savings Account For Retirement
Imagine an individual who has $10, of pre-tax funds available, is in a 25% tax bracket, and has a health insurance plan with a $3, deductible.
Option #1 might be to contribute $3, to a health savings account (subsequently paid out to cover the health insurance deductible). This leaves $7, of pre-tax income (after the HSA income), of which $1, (which is 25%) will go to taxes and the remaining $5, will be contributed to a Roth IRA. The end result is that the medical expenses have been covered (pre-tax) and the individual finishes with a $5, Roth IRA.
Option #2 instead is to contribute $3, to a health savings account (on a pre-tax basis), and then cover the $3, of anticipated medical expenses out of pocket. Since the health care expenses won’t likely be deductible, it will really require $4, of pre-tax income to have $3, left over. With the remaining $3, of pre-tax income, the individual can again pay the 25% tax rate, have $2, left over, and contribute that $2, to a Roth IRA. The end result is $3, in an HSA and $2, in a Roth IRA.
Notably, the outcome of this scenario is that when medical expenses paid out of pocket will not be deductible, the individual ends out with the same amount of total dollars in tax-preferenced accounts. It’s either $5, in a Roth, or $5, split between a Roth and an HSA. Arguably, in this scenario the HSA is not necessarily materially better, nor is it materially worse. Both accounts will be eligible for tax-free distributions for their respective purposes in retirement. The only difference is that distributions from the Roth IRA cannot be tax-free under age 59 ½, while earlier distributions from the HSA could be tax-free for medical needs (in exchange for the fact that over 59 ½ they’re still only for medical expenses).
Deductible Medical Expenses Above The AGI Limits And An HSA Contribution
For those whose medical expenses actually will be deductible – perhaps because income is low and the threshold can be reached, or because there are other medical expenses (e.g., for other family members) that together will add up to exceed the 10%-of-AGI threshold, the situation is different.
Continuing the prior example, now the individual contributes $3, to a health savings account, and “only” needs $3, of pre-tax income to cover actual medical expenses (since they are assumed to be deductible), and thus has $4, of pre-tax income left over, yielding health savings account rules retirement, as a Roth IRA contribution after 25% (or $1,) is held aside for taxes. The end result – in this case, there’s $3, in the HSA and also $3, in a Roth IRA.
In other words, to the extent that medical expenses actually will be deductible anyway, the tax savings on medical expenses frees up additional dollars to contribute to the Roth IRA. In essence, it’s a double tax deduction opportunity – for the medical expenses now, and for the HSA to fund medical expenses in the future, and the HSA grows tax-free in the meantime.
Again, this assumes the individual has enough free cash flow in order to fund all of these simultaneously – the HSA, the medical expenses out of pocket, and the Roth IRA. Nonetheless, to the extent there are dollars for all three, whenever the medical expenses are at least partially deductible, more dollars can be placed into tax-preferenced accounts.
HSA Contributions For Those Who Maxxed Out Retirement Accounts
In the scenario where retirement accounts have been fully “maxxed out” already (e.g., (k) plans, a pre-tax IRA or a backdoor Roth IRA, etc., have already been done), contributions to an HSA become even more appealing. Because in this situation, the “excess” dollars that don’t go towards medical expenses will simply end out in a taxable brokerage account, which is clearly less favorable than having dollars in a tax-preferenced health savings account for retirement.
For example, imagine again a scenario with $10, of pre-tax income to allocate, where retirement accounts are not an option because the contribution limits have already been reached. The first option, again, is to contribute $3, to the HSA and use those funds for the actual health insurance deductible; the remaining $7, of pre-tax income turns into $5, of after-tax dollars, which end up in a taxable investment account. On the other hand, if the HSA contribution is preserved in the account and the medical expenses are paid out of pocket, the investor finishes with $3, in the HSA and $2, in the taxable investment account. While the latter scenario still has a total of $5, in investment dollars, the difference is that now $3, of those funds will grow tax-free for the future!
When A Retirement Health Savings Account Can Beat A Traditional Retirement Account (Even With A (k) Match)
Notably, all of the earlier scenarios have assumed that the individual in question will have medical expenses to pay for in the what credit score you need for amazon credit card year (such that it's necessary to fund an HSA contribution and pay health expenses out of pocket). However, a unique situation arises when there actually are not necessarily going to be medical expenses to pay (e.g., because the insured is actually healthy and just doesn't anticipate any medical costs). In other words, what if there aren’t any dollars needed for medical expenses at all right now, and it’s just a question of which to contribute to – a retirement account like an IRA or (k), or a retirement health savings account instead?
All else being equal, the HSA will be the dominant account in this situation. The simple reason is that, as noted earlier, the HSA is both tax-deductible on contributions and tax-free on (qualified) distributions, while a retirement account is either tax-deductible up front or tax-free for distributions, but never both. In fact, the HSA is so dominant to a retirement account over a head-to-head situation, that it can be more profitable in the long run to contribute to an HSA even if the (k) has a small match.
For instance, if a contribution to a (k) offers a 25% match, but the individual faces a future tax rate of 20%, then $1 contributed to a (k) is still only worth $1 in after-tax value (as the match increases it to $ but the taxes decrease it back to $1). Which is exactly the same as simply contributing the $1 of pre-tax income to an HSA, also worth $1 of after-tax value. In turn, this means at any tax rate higher than the aforementioned 20%, it’s actually better to contribute to the HSA than to get the match with the (k). At combined state-plus-Federal tax rates of 45%+, an HSA can even be superior to a (k) with a cents-on-the-dollar match, as shown in the research below from a recent Journal of Financial Planning article entitled “”Could A Health Savings Account Be Better Than An Employer Matched (k)” by Greg Geisler.
Again, as noted earlier, a head-to-head contribution to an HSA over a (k) plan with a match only wins in situations where there are not any medical expenses to pay out of pocket. In scenarios where there are, it’s better to get the “double” tax benefits of contributing to the (k) and using the HSA to pay medical expenses on a pre-tax basis as well. But where there won’t be any anticipated medical expenses, the HSA especially shines.
Which arguably means the starting point for anyone should be to contribute to the HSA first (if eligible), see if there are medical expenses later in the year (and whether they can or cannot be deducted if paid out of pocket), and then decide whether to contribute additionally to a (k) or IRA. Either way, the HSA would the starting point, and for limited dollars, might be the end point as well, given the inevitable combination of a health savings account and Medicare spending in the future! Though ultimately, the HSA is really the best savings account for retirement for those who can afford to contribute to retirement accounts, and chase atm customer service phone number HSA, and have the cash flow or reserves to pay medical expenses out of pocket as well, to truly maximize the total dollars in tax-preferenced accounts! Presuming, of course, that the HSA dollars will be invested for growth in the long run, and not held in a cash or low-return holding account!
So what do you think? Do you ever counsel clients to contribute to an HSA before a retirement account? Would you consider doing so in the future?
Medicare’s tricky rules on HSAs after age 65
Before the tax-savings wonder that is the health savings account (HSA) was introduced init was a generally accepted best practice for any worker who wasn't already collecting Social Security at the age of 65 to go ahead and sign up for Medicare Part A (hospital insurance), regardless of other coverage. By being "in the system," the person was more likely to avoid penalties for late enrollment in Part B (medical insurance), Part D (prescription drug coverage), or other Medicare policies if he or she continued working with employer-provided health health savings account rules retirement coverage, with no additional cost in premiums (since Part A is free).
This rule of thumb still applies, for the most part, but a crucial exception arises for anyone who works past age 65 and wishes to continue contributing to an HSA. As this article discusses, individuals who enroll in Medicare Part A are not allowed to continue funding their HSA.
MEDICARE RULES OVERVIEW
A high-level overview of the Medicare enrollment rules is in order. According to mynewextsetup.us:
1. Taxpayers already receiving Social Security at their 65th birthday will automatically be signed up for Medicare. Taxpayers who aren't yet collecting Social Security and are still covered by an employer's group health plan because they are actively working (retiree medical plans do not count) may wish to defer signing up for Medicare at their 65th birthday in order to continue contributing to an HSA.
2. Besides the special enrollment periods available to workers who defer Medicare due to other eligible coverage, there are only certain times of year that Medicare recipients can sign up for or change coverage, which is why getting the sign-up process right is so important.
3. Signing up for Medicare Part B when first eligible avoids penalties. Generally speaking, taxpayers are able to defer Medicare past age 65 if they work for an employer with 20 or more employees while also enrolled in a group health plan based on that employment. However, they will need to take action to enroll upon leaving that plan in order to avoid lifetime penalties for late enrollment in Medicare Part B.
ELIGIBILITY FOR HSA CONTRIBUTIONS
There are lots of quirks involved when determining whether a taxpayer is eligible to make contributions to an HSA (which are always tax-deductible as long as they are allowed), most of them having to do with health care plan design. But a separate rule that often trips up taxpayers is that HSA contributions are disallowed when a taxpayer has other coverage in addition to an HSA-eligible plan (Sec. (c)(1)(A)(ii)).
This applies to taxpayers whose other coverage is TRICARE (the health care program for uniformed service members, retirees, and their families). It also applies to anyone whose spouse is using a flexible spending account, which is technically other coverage under the HSA rules (limited-use flexible spending arrangements (FSAs) are the exception here santander consumer usa my account login are typically offered alongside HSAs when available). Where this can get really sticky (and the focus of this article) is when a taxpayer works past age 65 with HSA-eligible group health coverage.
MORE KEY FACTS AFFECTING MEDICARE AND HSA COORDINATION
It's simplest to lay out the facts followed by an example to best help taxpayers and their advisers apply the nuances to specific situations:
- HSA contributions (including employer-provided ones) are disallowed when other coverage is in place, including Medicare Part A. Workers can still enroll in HSA-eligible plans and use funds already in HSAs for eligible expenses; they just can't contribute further once enrolled in Medicare.
- Workers may opt to participate in an HSA-eligible plan after enrolling in Medicare, typically because it's the only plan available to them at their workplace or because the lower premiums justify the choice, but they cannot contribute additional funds to their HSA nor can they accept contributions from their employer without penalty.
- There is a six-month lookback period (but not before the month of reaching age 65) when enrolling in Medicare after age 65, so a best practice is for workers to stop contributing to their HSA six months before enrolling in Medicare to avoid penalties. See the examples below for more on this.
- Funds already in the HSA can still be used for qualified medical expenses upon enrollment in Medicare, including to reimburse taxpayers for Medicare premiums (but not premiums for Medicare supplemental first fidelity cup norman as well as to pay for long-term-care costs and insurance.
- If a worker is already collecting Social Security upon turning age 65, he or she will be automatically enrolled in Medicare and henceforth no longer be able to contribute to his or her HSA. The only way to opt out of this would be to rescind the Social Security election (within 12 months) and pay back all benefits received to date.
- A worker enrolling in Social Security upon reaching full retirement age will automatically be enrolled in Medicare Part A and consequently cannot make HSA contributions.
Example 1: To illustrate how the six-month lookback period operates, let's say that A plans to work until age 67 in order to reach her full Social Security retirement age and opts to defer Medicare until then as well in order to continue funding her HSA. If A's birthday (and therefore her Social Security and Medicare enrollment date) is July 1 or later that year, she simply needs to stop any contributions to an HSA during the calendar year of retirement six months prior to her birthday.
Example 2: Using the above example, except for changing A's retirement date to April 1,her Medicare enrollment with the six-month lookback would actually be Nov. 1, If A fully funded her HSA by the maximum allowable amount forshe would need to recalculate for the two months of ineligibility then take steps to remove the excess contributions from the account. If A had already filed her income tax return before removing the excess contributions, an amendment may be in order as well to account for the loss of the tax deduction taken for ineligible contributions.
OTHER RULES TO KEEP IN MIND
Note that to defer Medicare past age 65, the taxpayer must be enrolled in an employer-based group health plan. An HSA-eligible plan through the private marketplace, COBRA, or a health care exchange does not suffice, and in that case, he or she must cease contributions to the HSA upon reaching age 65 health savings account rules retirement enroll in Medicare to avoid lifetime late-enrollment penalties.
Once a taxpayer is age 65 or older and no longer has coverage through an employer-based group health plan, he or she has eight months to enroll in Medicare Part B to avoid a penalty. If that deadline is missed, there is a risk of a lifetime penalty for late enrollment as well as being unable to enroll until the Jan. 1—March 31 window, which doesn't start coverage until July 1. In other words, getting the Medicare Special Enrollment Period wrong risks a gap in coverage plus a lifetime of penalties.
It's a best practice for taxpayers to go ahead and enroll in Medicare Part B as soon as they decide to retire in order to avoid this scenario.
THE BOTTOM LINE
When taxpayers opt to continue working past age 65 and wish to continue funding an HSA, they need to be very clear on the Medicare rules of enrollment to avoid either penalties for excess HSA contributions or late-enrollment penalties for Medicare Part B and Part D.