Anyone saving for retirement who doesn’t factor healthcare costs into the amount they will need risks coming up short and outliving their money or being forced to downsize their anticipated retirement lifestyle.
Fidelity’s latest survey puts the healthcare costs for a couple both aged 65 at $260,000. This is up from $245,000 in their 2015 survey and $220,000 in 2014. This is a big number even for those with sizable retirement nest eggs.
What Is an HSA?
An HSA is a medical savings account that can be used only in conjunction with a high-deductible health insurance plan. To qualify, the plan’s deductibles must be at least:
- $1,300 for an individual, or
- $2,600 for family coverage
HSAs are funded with pre-tax contributions that can be withdrawn tax-free to pay for qualified medical and dental expenses, including Medicare premiums and the cost of tax-qualified long-term care insurance. High-deductible plans are common among health insurance options offered by many employers and may also be available to those buying private insurance policies.
The maximum pre-tax contributions for 2017 are:
- $3,400 for a single person, or
- $6,750 for a family.
- Those 55 and over can contribute an additional $1,000.
In addition to these amounts, some employers also make contributions to employees’ accounts.
The Retirement Savings Opportunity
Flexible spending accounts (FSAs) and HSAs both allow for pre-tax deferrals to cover qualified medical expenses. The FSA has a “use it or lose it” provision that says all funds deferred during the year must be used by the end of the year; otherwise, the money is lost to you.
HSAs allow you to carry any unused money over to the following year and beyond. Many employers and investment custodians, like Vanguard and Fidelity, offer investment accounts for HSAs where you can invest in mutual funds and other long-term investment vehicles.
For those who have access to a high-deductible health plan and who can afford to cover medical expenses out of pocket from other sources, the HSA represents an ideal way to save for the costs of healthcare in retirement.
The use of an HSA can be even more appealing for those of you who already contribute the maximum to your 401(k) or similar employer-defined contribution plan, or to an IRA. The HSA contribution amounts are not limited by your income or impacted by the amounts contributed to other retirement savings vehicles.
Factoring the HSA Into Your Retirement Planning
For those who can manage to save all or most of their HSA money until retirement, the money can be used to cover any number of medical and health-related costs including these:
- Medicare premiums, though not Medicare supplemental policies
- Out-of-pocket costs such as co-pays and deductibles
- Dental and vision expenses that are not covered by traditional Medicare
- Prescription drugs and insulin
- Premiums for tax-qualified long-term care policies.
Best of all, the money comes out tax-free, with no required minimum distributions like a traditional IRA or 401(k) account. Note that once you are on Medicare, you can no longer contribute to an HSA; an HSA must be associated with a high-deductible health insurance plan.
The tax benefits of the HSA are undeniable, whether you can defer using the money until retirement or not. The ability to contribute on a pre-tax basis will lower your tax bill each year and is a way to make pre-tax contributions to a retirement vehicle other than your 401(k), even if your income does not allow you to contribute into an IRA.
For those who can reap the benefits of pre-tax contributions and tax-free growth in the balance and can defer using some or all the money until they retire, this is the best of all worlds.
When You Die
If your HSA account does not have a designated beneficiary, any unused money in your account at your death would revert to your estate and become taxable as part of your final income tax return.
If you are married and your spouse is named as the beneficiary, he or she can treat it as their own, just like an IRA. They could use it for their qualified medical expenses as intended.
If the beneficiary is someone other than your spouse, the account will be closed and the money will become taxable to them. The exception to this is that they have up to a year after your death to use the money to cover any remaining eligible medical expenses of yours.
HSAs are an excellent retirement savings vehicle for those who are eligible. They can be used in conjunction with other accounts, such as a 401(k) or an IRA. The tax benefits on both the front and the back end make the HSA an ideal way to cover the ever-increasing costs of healthcare in retirement. If you have the option of a high-deductible health insurance plan and an HSA, this is something to consider during your next open enrollment for employee benefits.