If you are in a High Deductible Health Insurance Plan (HDHP), you have access to one of the best retirement savings vehicles available today, the Health Savings Account. Yes, you read that correctly, in my opinion, your Health Savings Account, or HSA, is best thought of as a retirement account.
Retirement? Aren’t HSA’s for health insurance?
HSA’s were created to provide a tax advantaged way to save money for paying the HDHP’s annual deductible. Current (2018) annual HSA contribution limits are $3,450 for single plans and $6,900 for family plans. Those 55 and older can kick in an extra $1,000 per year. And unlike the old flexible spending accounts that required you to spend them down every year or risk losing money, unused HSA balances rollover indefinitely.
So, they are a great way to set aside money for HDHP deductibles and co-pays. And, for those with the financial ability to pay their expenses out of pocket and still fund an HSA, they can be fantastic retirement savings vehicles! Even better in some ways than the usual plans (e.g. 401(k), 403(b), IRA, Roth IRA) that were intended for retirement. Let’s look at some reasons why.
Triple Tax Advantaged
Retirement accounts are generally tax advantaged in 2 out of 3 areas. Traditional IRA’s and 401(k) plans allow you tax free contributions and tax-deferred growth while all retirement distributions are taxed. For Roth accounts, contributions are taxed, growth is tax-deferred and distributions during retirement are tax-free. So while there are tax benefits to conventional retirement accounts, the IRS still gets their portion. You just get to choose whether you want to pay on the front or back end.
Health Savings Accounts are an exception. They are tax advantaged in all 3 areas. Contributions are tax free, growth is tax-deferred, and distributions for qualified medical expenses are tax-free.
The tax-deductibility of HSA contributions work similarly to IRA contributions in that you don’t need to itemize deductions to benefit. This is great news for many as the new Tax Cuts and Jobs Act (TCJA) and its almost doubling of the standard deduction will make itemizing deductions a thing of the past. The independent Tax Policy Center estimates are that somewhere between 21 and 27 million taxpayers who itemized returns for 2017 will instead take the standard deduction in 2018. HSA contributions will be one of the few areas for many taxpayers to further reduce their bills.
And, unlike with IRA contributions, the tax-deductibility of HSA contributions doesn’t phase out at higher income levels.
Yours for Life
Next, HSA’s are portable; meaning that if you switch jobs or health insurance plans, you keep the account. Note that if you happen to switch from a HDHP plan to a plan that doesn’t qualify for an HSA, you cannot continue making contributions to the HSA. However, you can still keep the account indefinitely and use the funds to pay for qualified medical expenses not covered by insurance. And, most important for retirees, these benefits continue even after you switch from private health insurance to Medicare.
Additionally, funds from an HSA may be used to pay medical expenses for spouses and dependents. This is true regardless of whether they are covered by an HDHP, some other form of insurance such as an HMO, PPO or Medicare, or even no insurance at all.
And, if you predecease your spouse and had named them as the beneficiary, they will be able to take over the HSA as their own. They get to continue using it tax-free for themselves and any dependents. Once they pass or if you named someone else or the estate as beneficiary, the HSA loses its tax status. Any remaining funds are then taxable to the beneficiary or the estate in the year of the HSA owner’s death.
Invest it like an IRA
The vast majority of HSA plans languish in savings style accounts paying little to no interest. For those that plan use the funds to pay their out of pocket medical expenses over the coming year, this is fine. However, to really make use of an HSA as a retirement account, it should be invested similarly to an IRA/401(k).
Many employers have a default HSA trustee. If that trustee allows you to invest the account, great! If not, the good news is that, like an IRA, you can open an account with any HSA trustee. A quick Google search will turn up any number of companies which will allow you to invest HSA funds. If you work with a financial advisor, they may also be able to manage the account for you.
Note that if you contribute to your HSA through payroll deduction and/or your employer makes contributions on your behalf, they may restrict those contributions only to the default trustee. In that case, you will need to periodically transfer the funds into your investable HSA account. Be sure to check if either account charges transfer fees and plan accordingly.
What about the Qualified Medical Expense restriction?
Since the money in these accounts is essentially tax-free, it’s logical to think that the Feds would put very restrictive rules on how funds may be used. So what counts as a qualified medical expense?
IRS publication 502 has the comprehensive list, but here are some common examples.
- Health insurance premiums, copays and deductibles. This includes Medicare Part B & Part D
- Prescription drug co-pays
- Dentistry, eyeglasses & contacts (Not typically covered by Medicare)
- Long Term Care expenses, including LTC insurance premiums
- Medically necessary home modifications (i.e. wheelchair ramp, grab bars, door hardware, etc.)
It doesn’t take long for these expenses to add up, especially during retirement. A recent Fidelity study states that a 65 year old couple will spend another $280,000 in lifetime health care expenses. These costs, which will continue to climb, means it’s not likely an HSA will be over-funded, regardless of your current age.
And, if you’re lucky enough to avoid significant medical expenses during retirement or just want to use the money for other expenses, HSA distributions are treated like IRA distributions. In other words, if you take a non-qualified distribution after age 65, you only pay income tax. If you take a non-qualified withdrawal before age 65, however, there is a 20% penalty in addition to income tax.
Great complement to other retirement funds
While HSA accounts weren’t originally intended to be used as retirement accounts, their features make them a valuable option. Just make sure to keep a few things in mind.
- Like other retirement accounts, to make best use of an HSA, you will need to be able to fund it and leave it alone. This means using other funds to pay medical costs not covered by your HDHP.
- To make the most of it’s tax benefits, it needs to be invested like other retirement accounts
- They are less flexible for estate planning. Non-spouse beneficiaries must immediately pay taxes on any unused balance.
So if you currently have an HDHP plan or have the ability to switch to one, it’s worth thinking about how an HSA may be optimally coordinated into an overall retirement funding strategy.
(Other Sources: IRS Publication 969)