Are You Maximizing Your HSA?
By Jamie Dunn, CFP®
What is the only account that provides tax savings when you contribute to it, tax savings when you withdraw from it, and can help you manage your healthcare costs both now and after you retire?
A Health Savings Account, or HSA.
An HSA is one of the most flexible investment accounts there is. If you use it to its fullest potential it can provide you with a triple tax benefit and flexibility for current and future expenses.
What is an HSA?
An HSA is an account for US taxpayers who are enrolled in a high-deductible health plan. Employees contribute pre-tax dollars to their HSAs; in some cases, employers contribute as well. There are no taxes if funds are withdrawn to pay for qualified medical expenses.
Funds can be rolled over year after year, even after retirement, making an HSA a tool retirees can use to cover medical expenses. The IRS limits the amount consumers can contribute to an HSA: in 2020 the contribution limit is $3,550 for self-only and $7,100 for families. There’s also an additional “catch up” contribution of an additional $1,000 for individuals 55 and older.
Looking ahead to retirement
What are the three biggest concerns in retirement?
According to a recent study by the American Institute of Certified Public Accountants (AICPA), the three biggest concerns are:
- Maintaining their current lifestyle and spending habits
- Paying for rising healthcare costs
- Running out of money
Before retirement, most people have a steady paycheck, and they know how much it’s going to be. Even people whose paychecks vary, such as salespeople who earn a commission, have a sense that, “This is going to be a good (week/month),” or not.
In contrast, most retirees face a variable income, depending upon their investments, account balances that are dropping, and healthcare costs that are rising. A recent study by Vanguard and Mercer Health and Benefits pegs those costs for a 65-year-old woman at an average of $5,200 per year, or $433.33 per month. For many Americans that is a high monthly bill, and I don’t blame retirees for feeling anxious about it.
Three reasons an HSA can lower anxiety
Here’s how contributing to an HSA can help assuage those retirement concerns.
An HSA has a triple tax benefit.
Contributions to an HSA are tax deductible, accounts grow tax free, and distributions used for qualified healthcare expenses are tax free. No other retirement account has all three benefits. A Traditional IRA allows tax deductible contributions but the distributions are taxed. A Roth IRA allows for tax free distributions but provides no tax deductions for the contributions. Having an HSA provides the best of both types of retirement accounts to form a super saver.
You can use it as a tax-free savings account for future expenses.
With an HSA, employees can save current healthcare expense receipts, pay current healthcare bills out of pocket, and then take a tax-free distribution some time in the future using those receipts.
For example, say you buy prescription glasses for $200 in 2020. Instead of using your HSA to pay for it, you save your receipt. You now have $200 for spending some time in the future. This $200 can be spent on anything, as long as you have the original healthcare receipt. The $200 distribution you take for your glasses will be tax free. So in 2030, if you need $200 you can pull that amount from your HSA, rather than from your retirement accounts, and spend it on anything.
What’s great about this is you don’t have to reach retirement age, nor is there a time limit for you to use that 2020 healthcare expense.
After age 65 your HSA essentially turns into a Traditional IRA.
After you turn 65 you can use your HSA for any expense, not just health expenses. Younger people who withdraw money from an HSA for non-healthcare expenses must pay income taxes plus a penalty; that penalty is eliminated at age 65.
This is great because you don’t have to worry about saving too much in your HSA and then not being able to use that money. If, say, you’re 70, healthy, and don’t anticipate significant medical expenses in the near future (and don’t have past medical receipts), you can treat that money as if you were withdrawing it from a traditional IRA.
In a traditional IRA, starting at age 59 ½ you’d pay income taxes on withdrawals, but no penalties. An HSA can work that same way starting at age 65.
As you can see, this savings account is highly flexible and can be a great tool in your retirement toolkit. Before you make that move, though, talk to your financial planner and see if this is a tool that makes sense for you.