Bulk up Your Retirement Nest Egg with Health Savings Accounts
The HSA: It’s a bird! It’s a plane! Is it a Super Account?
The Health Savings Account (HSA) falls into the alphabet soup of marginally understood tax- advantaged savings vehicles. We may find them beneficial, but a bit confusing given their evolution from earlier medical savings accounts that had slightly different rules. It really pays to understand the basic HSA rules. Even better, it pays to understand the potential of the HSA. We’re always happy when something good becomes something even better, and Healthcare Savings Accounts have potential to become a very flexible tax-advantaged retirement vehicle!
The primary purpose of the HSA is to help people cover the high deductible associated with many modern health insurance plans. The HSA is only available in concert with a high deductible health insurance plan (HDHP – more letters for the alphabet soup) that requires a minimum deductible of $1350 for an individual or $2700 for a family whether offered by an employer or purchased individually. HSAs are generally established at a bank or financial institution and account holders use a check or debit card to dispense their funds for medical expenses. They can be funded on a pre-tax basis by employers and added to by employees up to an annual limit of $3450 for an individual and $6850 for a family for 2018. There is also an increased annual “catch up” contribution amount of $1000 for persons over age 55. So, if you are fortunate, and have relatively low healthcare costs over the years, then the HSA can accumulate some pretty significant savings.
For those who experience a lot of healthcare costs, there may be a very real need to spend the HSA balance to financially stay afloat. For many, especially those blessed with good health and low medical costs during youth and middle age, not using the HSA to cover expenses such as co-pays, prescriptions, deductibles and other relatively low healthcare costs, allows the HSA to accumulate.
Why would you want to accumulate a balance rather than pay healthcare expenses from the HSA? First, the account can be used to cover qualified healthcare costs tax-free for the rest of your life and the life of a spouse. For the average retiree, this could be a long period of time. It’s generally a bad idea to spend HSA funds on non-medical expenditures, since non-medical expenditures not only become taxable in the year spent, but also, a 20% penalty applies. This rule lapses once the HSA owner reaches age 65. At this point, the accumulated funds in the HSA can be used for any purpose and no 20% penalty applies. Funds dispensed for non-qualified medical purposes are taxable as ordinary income, much like IRA proceeds. Again, at any age, if the owner spends the funds on qualified medical expenses, the funds can be spent tax-free.
HSAs may be especially beneficial in retirement, but they must be accumulated in youth and middle age. Once Medicare begins at age 65, HSA contributions must cease, but ownership of the accumulated HSA account remains intact much like funds accumulated in an IRA or other retirement plan. Similar to the IRA, if a spouse dies with an undisbursed HSA and leaves it to the surviving spouse, the survivor may assume the HSA as his or her own tax-free. Unlike an IRA, if the HSA is left to someone other than a spouse, it passes to the survivors as taxable income.
There are plenty of medical uses for HSA funds that may not be covered by Medicare or any other insurance plan, which makes the accumulated balance especially helpful to elders. Examples include visits to the dentist’s office for cleanings, fillings, dentures or extractions. You can use your HSA to cover these costs especially if you do not have dental insurance, which usually provides only partial coverage on more involved procedures. Even Medicare Advantage plans that cover most of these costs have an annual maximum benefit of around $1500. Medicare also doesn’t cover routine eye exams or glasses (except one annual eye exam if you have diabetes or eyeglasses after having certain kinds of cataract surgery.) Most health insurance plans don’t cover routine hearing exams and none cover hearing aids, which can cost as much as $5000 per ear. Hearing loss can happen any time to anyone, not just to senior citizens.
To learn more about HSAs and what constitutes a qualified medical expense, read IRS Publications 969 and 502, available here: https://www.irs.gov/publications/p969; and here: https://www.irs.gov/publications/p502. It is also a sound plan to understand what your insurance plan covers. Check in with your insurance or employee benefits professional to access your policy information online. To find out what Medicare covers, go here for the “Is my test, item, or service covered” tool: https://www.medicare.gov/coverage/your-medicare-coverage.html
HSAs are wonderful tax advantaged accounts that can help ease medical costs. Some of the perks include:
• Tax deductible contributions
• Tax-free interest and earnings growth
• Tax free distributions for qualified medical expenses
• Many HSA plans allow for investments such as stocks, bonds, mutual funds and ETFs
• Contributions can build year after year with no need to take distributions until you need them for qualified medical expenses
• A surviving spouse named beneficiary of the HSA may use it as their own tax-free account for medical expenses
HSAs do have a few drawbacks: for persons under the age of 65, there are penalties if the funds are used for anything besides qualified medical expenses. The annual contribution limit is lower than that of an IRA and other tax-deferred retirement plans. You must have a high deductible health insurance plan to open a Health Savings Account. However, for those covered by such a plan who have maxed out their savings in other tax-deferred accounts such as employer retirement plans, IRAs, and Roths, the HSA is another vehicle for tax-deferred savings, With the sterling feature of lifetime tax-free distributions for qualified medical expenses, the HSA may well be a Super Account, and the little duckling that blossoms into a retirement swan.