Run, Don’t Walk: Utilizing the Triple Tax Benefits of an HSA
Health Savings Accounts (HSA) are one of the most misunderstood and underutilized opportunities for tax-friendly retirement savings. Many individuals who qualify for these accounts either falsely believe that they are only beneficial for covering medical expenses or are dismayed because the accounts have caps on annual contributions. But, the value of an account that allows assets to grow tax-deferred should never be outruled, even by high-income earners.
An HSA is one of only three types of savings accounts which are allowed to grow tax-free (the other two are the 529 college savings plan and the Roth IRA). But, the HSA offers a triple tax break all rolled into one:
- Contributions are tax-deductible (or pre-tax if made through an employer)
- Money grows tax-deferred
- Withdrawals made for qualified medical expenses are made tax-free
With pre-tax treatment on contributions on the front end, tax-deferred growth over time, and tax-free withdrawals for health-care related expenses, this savings route has the potential to significantly save investors who would have otherwise invested in a taxable account. A 40-year old woman who begins making the maximum annual contributions of $3,500 to her HSA today (with a conservative presumed average annual rate of return of about 5%) could have $187,000 by the time she hits 65 available to pay for medical expenses during retirement.
Since the tax benefit on the withdrawal end is only available for qualified medical purchases, more diligence will need to be paid to record-keeping (saving receipts, bank statements, etc.) in order to prove where funds were spent.
Withdrawals used for non-healthcare related expenses will be subject to your ordinary income tax rate; however, funds withdrawn before age 65 and not used for medical expenses will also be subject to a 20% penalty.
As mentioned above, many individuals see the medical expenses caveat as a deterrent when opening an HSA. But, what is ignored here is the fact that medical expenses are statistically the biggest potential liability in retirement with the average healthy couple at age 65 projected to spend anywhere between $250,000 and $500,000 on health care during retirement alone. And since the HSA is only a supplemental aspect to any retirement plan, the account will ideally be reserved for covering medical expenses before being put to use elsewhere. For all other expenses, traditional retirement accounts can be utilized.
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Many people are also unaware that the funds from these accounts can be used to retroactively reimburse the account holder for any medical expenses incurred after the account was opened. The expenses do not have to be incurred in the same year as the withdrawal. Therefore, some individuals will choose to pay for healthcare expenses out-of-pocket up-front, allowing their investments in the HSA to grow untouched. Later down the road, they use the tax-deferred HSA to reimburse these older expenses tax-free.
However, not everyone qualifies to open an HSA. Only individuals with High-Deductible Healthcare Plans (HDHP) are eligible to open an HSA. In 2020, the deductible must be at least $1,400 for an individual on a single policy and at least $2,800 for a family policy. Additionally, an ADHP’s total yearly out-of-pocket expenses cannot exceed $6,900 for an individual and $13, 800 for a family.
Common Mistakes to Avoid
- An HSA is not FSA: An HSA is not a Flexible Spending Account (FSA) and won’t be lost if it isn’t spent within the calendar year. Many people confuse these two types of accounts, spend their contributions, and defeat the purpose of the HSA altogether, which is to save. The best option for those who don’t need to use the funds to cover medical expenses in the present is to treat the account like any other retirement account by putting the money into it and letting it grow untouched.
- Invest, Invest, Invest: An HSA is an account that holds funds, but the types of funds you hold in that account are up to you. You can choose from value funds, equity funds, or growth funds depending on your goals and timeline. Leaving the funds in the default money market account is not ideal for long-term growth.
- Check for an Employer Match: Sine HDHPs tend to save employers money, many companies are offering incentives for those employers who enroll in them. One such incentive is the employer match. Employees who don’t take advantage of an employer match are essentially missing out on free additional funds and tax benefits. Check with your benefits package to see if HSA contribution matches are offered.
- Think Twice Before Taking Social Security Benefits: Once you reach age 65 you will likely sign up for Medicare Part A. Once you’ve signed up for Medicare, you cannot continue to contribute to an HSA, so you’ll need to take an overview of your financial picture and decide which route will make the most sense (perhaps delaying Medicare enrollment) for your budgeting and tax planning strategy.
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Not only are HSA useful tools for paying medical expenses over the course of a lifetime, they can be used as tax-deferred savings vehicles for retirement expenses. With medical expenses being the most cumbersome financial liability for retirees, the HSA can provide some much-needed financial relief in approaching these costs.
If you or a loved one would like to learn more about how to incorporate a Health Savings Account (HSA) into your retirement plans, contact us today to schedule a complimentary Get Acquainted meeting with one of our seasoned retirement experts. Not only are we committed to helping you achieve what is meaningful in retirement, but in supporting you through the transition to get there.