Health Savings Accounts as Retirement Savings Vehicles
While the primary purpose of a Health Savings Account (HSA) is tax-incentivized medical expense savings, the benefits of the HSA as a long-term investment option for retirement saving continues to grow in popularity. At its most basic, an HSA is a savings account for medical expenses to which you can contribute pre-tax funds. From a long-term planning perspective, HSAs make great retirement income vehicles.
Certain criteria are required to be eligible for an HSA. You must be insured under a High Deductible Health Insurance Plan (HDHP). For 2021, this means an out-of-pocket maximum of $7,000 and a minimum deductible of $1,400 for an individual; $14,000 maximum out of pocket for a family plan and $2,800 minimum deductible. You must not be covered by any other health insurance plan (for example, a spouse’s non-HDHP plan), and you must not be enrolled in Medicare or claimed as a dependent on a tax return.
If you are eligible for an HSA, you can contribute up to $3,600 for an individual plan and $7,200 for a family plan in 2021, with an additional $1,000 contribution available for those over age 55.
HSAs come with a triple tax benefit – contributions are made pre-tax; growth is tax-deferred, and withdrawals for qualified medical expenses are tax-free. Employers may also contribute to employees’ HSAs; such contributions are not considered taxable income to employees.
Tax treatment of HSA funds is similar to IRA funds, with the exception of tax-free use for medical expenses. Withdrawals for non-medical expenses prior to age 65 will incur tax and a 20% penalty. After age 65, withdrawal of HSA funds for non-medical expenses will incur taxable income, but no penalty. Use of HSA funds for medical expenses after age 65 remains tax-free.
Contributions to HSA funds are most often made through payroll deductions, but you can contribute outside your payroll. Payroll contributions will be excluded from taxable income. Outside contributions will be reported on your income tax return and considered as pre-tax, reducing tax liability. Annual contribution limits are not subject to income limitations.
You can contribute to an HSA until you enroll for Medicare. However, you are not required to use HSA funds for medical expenses in retirement, and there is no required minimum distribution from HSA accounts after retirement, or at certain ages, as with more typical retirement savings accounts.
A spouse will inherit an HSA tax-free. Receipt of HSA funds by a non-spouse beneficiary will be considered taxable income to that beneficiary for the fair market value of the account. (Remember, none of these dollars were taxed during your lifetime.)
HSA funds can still be used tax-free in retirement for medical expenses, including Medicare premiums, a portion of long-term care insurance premiums, in-home nursing care, or nursing home expenses, even for accessibility modifications for your home if needed (such as ramps, handrails, etc.).
Unused HSA funds rollover to the next year, continuing to grow tax free. Typically, HSA accounts valued over $2000 can be invested, though you will want to check with your plan administrator on options and rules. HSAs are portable and can be taken with you if you change jobs or upon retirement.
If you typically have low medical expenses and a high deductible health insurance plan, you might think, why bother to maximize the HSA contribution when I don’t need to use it? You might consider maxing out your HSA contribution in addition to maximizing 401K or IRA contributions (or even before). You might consider paying medical expenses out of pocket, particularly if you do not usually get close to satisfying your insurance deductible, leaving HSA funds to grow for medical expense use during retirement. The HSA offers tax free contributions, growth, and withdrawals (if for medical expenses), with no required minimum distributions during retirement. Why not save this great tax-free pocket of funds for a later day?
Using HSA funds for medical expenses in retirement can reduce dependence on other sources of taxable income for medical costs and could help keep your taxable income lower in retirement. Use of the funds in retirement for non-medical expenses will incur tax, but with no minimum distribution requirements, allowing you to cherry-pick which assets to use when for smart tax planning.
HSAs appear to be a relatively unknown and under-utilized gem in retirement planning. Though we often lament the cost of high-deductible health insurance plans, the HSA provides a great opportunity for long-term retirement savings.