Why an HSA Benefits Retirement

April 6, 2020

If you don’t already have a Health Savings Account (HSA), you should consider opening one because they can be a powerful investment vehicle to support your retirement. HSAs, which can grow over time with tax advantages, are more than just another way to pay for health care.

What is a Health Savings Account?

An HSA is a personal savings account that can be used to pay for certain qualified medical expenses. If you are enrolled in a high-deductible health insurance plan, you may qualify to contribute to an HSA. The IRS determines if your health plan allows you to open and fund an HSA by looking at the minimum deductible and the out-of-pocket maximum of your health plan.

If you qualify to contribute to an HSA you decide how much you want to contribute to your HSA account each year, up to the federal maximum. If you have an HSA through your employer, you can set up automatic contributions from your paycheck. 

In 2020, the maximum you can contribute to an HSA is $3,550 when you have an individual health plan or $7,100 when you have a family health plan. If you are 55 or older, you can contribute an additional $1,000 per year. This is called a catch-up contribution.

How to Use an HSA

You will get a debit card and/or checks linked to your HSA account, and you can spend the funds on eligible medical expenses, including deductibles, copays, and coinsurance amounts, plus other qualified medical expenses that aren’t covered by your plan. Generally, you cannot use HSA funds to pay insurance premiums.

You can invest your HSA funds into stocks, mutual funds, exchange-traded funds, and other investment vehicles. Depending on your needs, you may want to keep part of your HSA funds in cash equivalents and invest the rest of the account into a longer-term investment strategy.

Unlike a flexible spending account, your HSA balance automatically carries over from year to year, so you don’t have to worry about losing your funds at the end of the year if you do not use them. You can keep your HSA funds if you switch employers or retire. 

Once you’re over age 65 and enrolled in Medicare, you can no longer contribute to an HSA, but you can still withdraw the HSA funds to pay for your medical expenses. 

It is a bad idea to withdraw HSA funds for non-qualified expenses before you turn 65 because you’ll have to pay taxes on your withdrawals in addition to a 20% penalty. However, after you turn 65, you’ll only owe taxes if you plan to withdraw for non-qualified expenses without a penalty.

HSA Tax Advantages for Retirement

There are three tax advantages with HSA accounts.

  1. HSA contributions are deductible from your gross income and therefore not subject to federal income taxes. Likewise, in most states, HSA contributions are not subject to state income taxes.
  2. Withdrawals at any age from your HSA are not subject to federal taxes if you use them for qualified medical expenses. 
  3. Any interest or other earnings on the money in your HSA grows tax-deferred. If the interest or other earnings are used for qualified medical expenses then they are tax-free.

An HSA is one of the most tax-efficient savings options available. Therefore, you should consider contributing the maximum each year and paying for your current medical expenses from other sources, if possible. That way, your HSA has the opportunity to grow as much as possible before you retire.

Most people will experience a big increase in health care needs as they get older, so it’s wise to build up a substantial nest egg that you can use to pay medical bills or other expenses during retirement.

In addition, you can make a one-time rollover of money from your individual retirement account (IRA) to a health savings account without taxes or penalties. The process is called a qualified HSA funding distribution.

How to Use Your HSA in Retirement

After you retire, you can still use your HSA for things like dental care, hearing aids and eyeglasses. But there are several other ways you can use it, such as:

  1. Covering Medicare premiums. You can use your HSA to pay the premiums for Medicare Part B and Medicare Part D, but not a supplemental plan (called a Medigap plan). If you’re at least 65 and have employer-sponsored health coverage, you can use your HSA to pay your share of those premium costs, as well.
  2. Help you pay for long-term care insurance.
  3. Bridge to Medicare. Those who retire before turning 65 still need health insurance until they qualify for Medicare. If you enroll in COBRA coverage, you can use your HSA funds to pay the monthly COBRA premiums. 
  4. Pay for nonmedical expenses. Once you turn 65, you can use your HSA to pay for nonqualified expenses, but you will have to pay state and federal taxes on those distributions.

You should also select a beneficiary for your HSA so that a person can receive any remaining funds after your death. It’s a good idea to name your spouse as your HSA beneficiary because your spouse can inherit the entire account tax-free and continue to use it for medical expenses. If your child or another non-spouse beneficiary inherits your HSA, he or she will have to pay taxes on the account. Talk with a retirement advisor or estate planner to decide the best arrangement for you and your heirs.

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