Using a Health Savings Account for Retirement (Mid-3Q20 Newsletter)
Updated: May 17, 2022
September 15, 2020
Even as the world continues to experience unprecedented change, we are focused on our corporate mission: working with our clients to help them attain and sustain economic independence. Here we discuss the Health Savings Account and how to take advantage of its "triple play."
A Word from the Co-Editors
Kit-Victoria (Weil) Wells – Culture & Communications Officer
Catalina Cherny-Santos – Client Services Manager
As the world continues to experience unprecedented change, we at Christopher Weil & Company, Inc. stay focused on our corporate mission, namely working with our clients to help them attain and sustain economic independence. This includes making sure our clients take full advantage of the various investment options available to them. In this mid-quarter newsletter Rob Gaan tackles one of the important components of the employee benefits package – the Health Savings Account (“HSA”).
Using a Health Savings Account for Retirement
Robert Gaan, CFP® – Lead Advisor
A Health Savings Account (HSA) is a tax-exempt trust or custodial account that an employee can establish to pay or reimburse certain medical expenses in a highly tax-efficient way. HSAs offer an uncommon “triple play”:
tax-free growth, and
tax-free withdrawals for qualified medical expenses.
In addition, for people who have already “maxed out” their traditional retirement plan options (401(k) and/or IRA), contributing to an HSA may be an effective strategy to supplement retirement savings.
There are certain eligibility requirements for HSAs and not all employers offer the HSA option. HSAs can only be used in combination with a High-Deductible Health Plan which trades relatively low premiums for relatively high deductibles. In concept, participants can use the funds that accumulate in their HSAs to help pay healthcare expenses until the deductible on their insurance policy is met.
For 2020, you can contribute up to $3,550 to an HSA if you have a single health insurance policy or $7,100 if you have a family policy. Those who are age 55 or older can also make an additional $1,000 in “catch-up” contributions each year. The entire HSA contribution is pre-tax, regardless of your income, unlike IRA accounts where contribution amounts and deductibility could be affected by the amount of income that you have. Some employers even contribute to their employees’ HSAs, and those contributions may also be excluded from gross income. Interest and earnings within the HSA are not taxed.
Distributions from an HSA can be made tax-free if the withdrawals are used to pay for qualified medical expenses. HSA assets can be rolled over year to year and remain in the account until you use them. HSAs are not tied to a specific employer and will stay with you if you change employers or retire. If you later change insurance and no longer have a qualified high-deductible plan, you can still pay for qualified medical expenses out of your HSA. You just can't make any new contributions until you have an HSA-qualified plan again.
The Retirement Savings Opportunity
While HSAs are intended to provide a tax-free way to pay for non-reimbursed healthcare costs, you don’t have to use it when you incur medical expenses. Instead, you could pay any current medical bills that you have out-of-pocket and let the balance in your HSA grow. Also, while many HSA custodians offer simple savings accounts for participants to hold their contributions, some HSA custodians allow participants the ability to invest their deposits for the long-term. (Fidelity Investments recently announced that they will be offering HSAs which support long-term investing.)
Generally, if you withdraw from an HSA for non-medical expenses before age 65, you may have to pay ordinary income taxes on the withdrawal amount plus a 20% penalty. However, once you reach age 65, you can typically withdraw from an HSA penalty-free for any purpose (though you will still have to pay income tax on withdrawals for non-medical expenses). In this way, HSAs for people over age 65 are somewhat like traditional IRAs for people over age 59 1/2, but with two advantages: First, withdrawals from HSAs for medical expenses after age 65 are generally not taxed at all (whereas IRA distributions are); Second, HSAs have no minimum distribution requirement (whereas you must generally start taking required minimum distributions from traditional IRAs starting at age 70 1/2).
As with an IRA, you can name a beneficiary to receive any balance in your HSA at your passing. If you leave your HSA to a spouse, the balance will become his or her HSA; any other beneficiary will receive a distribution of the funds subject to ordinary income tax (but no penalty).
And HSAs are flexible in one more important way: there is no time limit on when you reimburse yourself for medical expenses. You may choose to initially pay for any unreimbursed medical expenses out-of- pocket, allowing the funds in your HSA to be invested and grow over the long term. If you keep a file of all the receipts from your paid medical expenses over the years and reimburse yourself (tax-free) in a lump sum in the year you retire, you have bolstered your savings for living expenses which may enable you to defer collecting Social Security payments. The longer you defer collecting Social Security, the greater your monthly payments will be when you do initiate your benefit.
Be aware that special distribution rules apply if you have both an HSA and a Flexible Spending Account (also known as FSA or Section 125 Account). Generally, if you have extra cash flow to invest for retirement and you’re deciding between an IRA, 401(k), or HSA, always choose to “max out” your IRA and 401(k) first. IRAs and 401(k)s are specifically designed for retirement and have many advantages that HSAs do not have. Afterward, if you find yourself with additional funds to set aside for retirement, consider “maxing out” your HSA.
Also, switching to a High-Deductible Health Plan just to take advantage of an HSA for retirement purposes may not be the best course of action. Before you use an HSA to save for retirement, make sure that having a High-Deductible Health Plan makes sense for you and your family. If you do decide that a High-Deductible Health Plan is right for you and your family, then an HSA may be a good way to supplement your retirement savings.
Download the Mid-Quarter 3Q20 Newsletter here.
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