How Can Your HSA Help You Save for Retirement?
During retirement, your health care costs are likely to increase. Even if you are fortunate enough to live for a long time and in good health, you will eventually reach an age where the cost of maintaining your health becomes more expensive. Even before that point, you will most likely need to pay for Medicare during retirement. This is just another argument for starting to save for retirement as early as possible. However, there is an often overlooked way that people can save for their future medical expenses: Health Savings Accounts (HSAs).
HSAs allow individuals and families to contribute money tax-free into accounts that can be used exclusively for qualified medical expenses when they become older.
What is an HSA?
A Health Savings Account (HSA) is a special tax-advantaged savings account that allows you to set aside money for medical expenses. Unlike a Flexible Spending Account (FSA), which must be used within a calendar year, HSAs can be invested for future years and are not lost if unspent at year-end. They're also different from Health Reimbursement Arrangements (HRAs), which are employer-sponsored accounts and must be used by the employer to reimburse employees' healthcare expenses.
HSAs can be established on an individual basis or a family member plan. They are not subject to penalties or federal income tax if they remain in the HSA, or if they are used for qualified medical expenses. In addition, they essentially turn into an IRA after retirement (subject to federal tax) – overall, they're an excellent tool for saving money!
Let's look at some other key differences:
The Advantages of HSAs:
- Tax-deductible contributions: The money you put into an HSA is tax deductible, which means it reduces the amount of taxable income you report on your taxes. For example, if you earn $50,000 and contribute $3,650 to an HSA (the maximum contribution for 2022), then your taxable income becomes $46,350—a difference of $3,650. Depending on your tax bracket, this will save you anywhere from 10% to 37% on that $3,650, or between $365 to $1350 in tax savings.
- Tax-free withdrawals: When it's time to take money out of your HSA account to pay for medical expenses (including those incurred by family members if on a family plan), that withdrawal is tax-free. HSAs are the only account that provide you with a tax incentive when you add to the account and still allow for tax-free withdrawals (for qualified expenses).
- Penalty-free withdrawals for non-medical expenses in retirement: If you use some or all of your HSA balance after age 65 as part of your retirement planning strategy (by withdrawing it as cash or using debit cards tied directly back into this account), then those withdrawals would be free from a federal income tax penalty. You will, however, be subject to federal taxes on HSA withdrawals during retirement if the funds are not used for medical expenses.
How to Set Up An Account
There are several ways to open a health savings account. You can find an HSA at many banks, credit unions, and broker-dealers. They are often paired with a checking account or even other financial services like investing products. Some health insurance companies will also offer HSAs for their customers to use, which may be easier than using a traditional bank account if that's your primary source of healthcare coverage. If you have health insurance through your job, ask if they offer HSAs as part of the benefits package; some companies do! (We can talk you through the process of setting one up here.)
How to Make Contributions
You can make contributions to your HSA at any time during the year. In fact, you can even make contributions while you’re enrolled in Medicare. Similarly, if you’re not enrolled in an HDHP, you may still be eligible for an HSA if your deductible is high enough. The IRS requires your deductible to be at least $1,400 for an individual or $2,800 for a family. The annual out-of-pocket expenses (including deductibles, copayments, and coinsurance) cannot be more than $7,050 for an individual, or $14,100 for a family (for 2022).
Health savings accounts (HSAs) have IRS contribution limits of $3,650 for individual coverage and $7,300 for family coverage in 2022. The IRS contribution limitations for HSAs in 2023 are $3,850 for an individual and $7,750 for a family. If you are 55 or older during the tax year, you can make an additional $1,000 catch-up contribution. Your spouse could also make a catch-up contribution if they are 55 or older, but they will need to have their own HSA.
Using Tax Advantages
Understand the triple tax benefit and how HSAs work:
If you are enrolled in an HSA-eligible health plan at work or in the private market, you can contribute to an HSA. Most people use HSAs as a way to save for current medical expenses that are not covered by such plans. However, if you can pay for these expenses out of pocket, the triple tax-free nature of an HSA makes it a powerful retirement savings vehicle.
Many people contribute to HSAs through pre-tax payroll deductions; thus, their contributions are also exempt from FICA taxes. As long as you are enrolled in a qualifying health plan, you can form an HSA outside of work and fund it with after-tax money, which you can subsequently deduct on your personal tax return. These contributions can grow tax-free and can be withdrawn tax-free to cover current and future eligible medical expenses, including those incurred during retirement. If you are no longer covered by a qualified plan, you cannot make additional contributions, but you can continue to retain the account and your contributions will continue to grow tax-deferred.
It gets better: In contrast to most flexible spending accounts (FSAs), HSA funds may remain in the account from year to year. Your HSA can earn interest or earnings, and you can even take it with you if you change employers or retire.
Click here if you are interested in a tax advisory relationship with our affiliate, Vincere Tax.
HSAs are a great way to save for health care costs in retirement:
These accounts can be used to pay for non-medical expenses, too, which means you can earn interest on your money and not have to worry about tax consequences. You will also be able to avoid paying taxes on the money you withdraw when you use your HSA funds to pay medical bills or other costs associated with health care.
HSAs aren’t just useful for saving up for future medical costs—they also come with some great perks that make it easier to manage finances now: HSAs allow people who don't get their insurance through work (or who have low-cost insurance) an opportunity to save more than they would otherwise. These days, many employees don't even receive much in the way of vision coverage from employers!
You can always use your HSA to pay for qualified medical expenses, such as vision and dental care, hearing aids, and nursing services. After you retire, you can use the money in other ways:
1. Help the transition to Medicare
If you retired before you turned 65, you may still need health insurance until you are eligible for Medicare at 65. In general, HSAs can't be used to pay for private health insurance premiums, but there are two exceptions: paying for health care coverage bought through an employer-sponsored plan under COBRA and paying premiums while receiving unemployment benefits. This is true at any age, but it could help if you lose your job or decide to stop working before you turn 65.
2. Cover Medicare premiums
You can use your HSA to pay for some Medicare costs, like the premiums for Part B and Part D prescription drug coverage. However, you can't use it to pay for the premiums of a Medigap policy. If you are over 65 and your employer pays for your health insurance, you can also use an HSA to pay your share of those costs.
3. Costs for long-term care
Your HSA can be used to pay part of the cost of a "tax-qualified" long-term care insurance policy. You can do this at any age, but as you get older, you'll be able to use more.
4. Cover other costs
Once you turn 65, you can use your HSA to pay for anything that isn't a qualified medical expense. For example, you could use it to buy a boat. However, you won't get to take full advantage of the tax savings because you'll have to pay state and federal taxes on those distributions as they are not qualified medical expenses.
Let HSAs play a role in your estate plan
If your medical costs are much lower than average (or if you don't live that long), you may have money in your HSA that you can give to your heirs. The rules are complicated, so it's best to talk to an attorney or financial advisor who helps with estate planning.
Connect with Tim Uihlein here, our resident estate planning expert.
When figuring out what happens to your HSA assets after you die, there are usually three things to think about:
1. Spouse is the designated beneficiary
If you name your spouse as the beneficiary of your HSA, it will be treated as your spouse's HSA after you die, and it will still be tax-free in three ways.
2. Spouse is not the designated beneficiary
If your spouse isn't the designated beneficiary of your HSA, the account stops being an HSA, and the fair market value of the HSA is taxed to the beneficiary in the year you die.
3. Your estate is the recipient
On your final income tax return, you will list the HSA's fair market value. Many people would choose to name the surviving spouse as the beneficiary over the other two choices. But if you don't have a surviving spouse, you might want to think about how to pay the least amount of taxes. In that case, you might want to name as the beneficiary either your estate or the person who will get the money, depending on who is in the lowest tax bracket. Work with people who know about taxes and estate planning to figure out which choice is best for you.
Tip: If you name your estate as the beneficiary of your HSA, it will likely become a probate asset and still need to fit into your overall estate plan.
When you turn 72, you usually have to take required minimum distributions from traditional IRAs and 401(k)s and pay taxes on those distributions. For HSAs, there is no minimum amount that must be taken out. An HSA can help you save on taxes in three ways, so it's something you should think about if you want to protect your retirement now and in the future.
In conclusion, HSAs are a great way to save for retirement. You can use them for any health care expenses you have now or in the future, and you will never pay taxes on that money. They also give you tax advantages when you make contributions and withdrawals from your account. So if you're looking for ways to save more money or if your employer offers this option as part of their benefits package, then we would highly recommend taking advantage of it!
I hope this information was helpful. If you have any questions, feel free to reach out. I’d be happy to chat with you.
About the Author
As a Senior Wealth Manager here at Vincere Wealth, Jen helps clients navigate their financial challenges and decisions. Having someone guide you today in making sound financial decisions can have a substantial impact on your future financial well-being. Jen takes great pride in guiding clients through the complexities of student loans, retirement planning, and marriage and divorce planning.
If you're interested in an investment advisory or financial planning relationship, please consider Vincere Wealth Management.
Schedule a FREE 1:1 session here to connect with a #VincereWealth Advisor.