A health savings account (HSA) is well-known for helping to pay for out-of-pocket medical expenses, but it might surprise you to hear that this tax-advantaged account may also be a superior retirement savings vehicle. Here’s an explanation of what these accounts are, who should open them, the requirements, and how to make the most of a Health Savings Account for your retirement if you’re lucky enough to have a High deductible health plan. We are also going to look at the updated Health Saving Account (HSA) requirements for 2023 and how to make contributions.
What Is an HSA (Health Savings Account)?
HSAs are tax-advantaged savings accounts that aim at assisting individuals with high-deductible health plans (HDHPs) in paying for out-of-pocket medical expenses. Although these accounts have been available since 2004, far too few qualifying Americans have taken advantage of them
All of this means that customers who have HSAs, as well as those who are entitled but haven’t opened one, are losing out on a fantastic opportunity for financing their retirement years. It’s time to start something new.
Benefits of a Health Savings Account
One can make contributions to an HSA through payroll deductions or your own funds. If the latter is the case, they are tax exempt even if you do not itemize. If you pay for them with your own money, they call it pre-tax. This means they minimize your federal and state income tax liability—and they’re not subject to FICA taxes, either.
The money in your account grows tax-free. There will be no tax on any interest, dividends, or capital gains you earn. Any donations made to your HSA by your employer do not have to be part of your taxable income.
Withdrawals for eligible medical costs are exempt from taxation. This is a significant advantage with an HSA over a conventional 401(k) or IRA as a retirement vehicle. When you begin to withdraw funds from those plans, you must pay income tax on those funds, regardless of how you use them.
A Health Savings Account, unlike a 401(k) or an IRA, does not require the account holder to begin withdrawing funds at a certain age.
You can keep the account open for as long as you want, but you will no longer be able to pay until you enroll in Medicare.6 You become eligible for Medicare at the age of 65 and will be automatically enrolled in Parts A and B if you are already receiving Social Security.
Furthermore, you can roll the balance over from year to year; unlike a flexible spending account. An HSA can also accompany you to a new job. You own the account, not your boss, which means it is completely flexible and can go wherever and wherever you want.
Requirements for a Health Savings Account (HSA)
To be qualified for an HSA, you must meet the IRS’s criteria, which are as follows:
- On the first of the month, you must be protected by a qualified high-deductible health plan (HDHP).
- You have no other health coverage than what the IRS allows.
- You do not have Medicare, TRICARE, or TRICARE for Life.
- Also, you cannot claim as a dependent on another person’s tax return.
- Except for preventive treatment, you have not earned Veterans Affairs (VA) benefits in the last three months. This exclusion does not apply if you have a VA impairment ranking.
- You do not have a health insurance FSA or a health reimbursement plan (HRA). Alternative plan designs, such as a restricted-purpose FSA or HRA, may be allowed.
Other limitations and exceptions may apply. We suggest that you speak with a tax, legal, or financial professional about your specific Health savings account Requirements.
Read Also: HSA Investment: Best Options and Tax Benefits
Adult Children Coverage
Adult children up to the age of 26 have coverage under their parents’ insurance benefits, including high-deductible plans, under the health care reform law of 2010.
The tax laws governing HSAs have not changed, but an adult child must also be deemed a tax dependent in order for his or her medical costs to be paid or reimbursed from a parent’s HSA.
If you are under the age of 26 and you are under your parent’s HSA-eligible, high-deductible health plan, you will be able to open and finance your own HSA and contribute up to the IRS family limit. The conditions outlined above remain in effect. Consult an experienced benefits manager or tax advisor.
How to use a Health Savings Account (HSA)
Overall, an HDHP can be more cost-effective than you think, particularly when you consider its retirement benefits. Let’s look at how you may be able to use the features of an HSA to more effectively and robustly finance your retirement.
Max Out HSA Contributions by Age 65.
As previously stated, your HSA payments are tax-deductible before you enroll in Medicare. Employer contributions are part of the contribution caps of $3,550 for self-only coverage and $7,100 for family coverage. The HSA contribution limits are adjusted for inflation on an annual basis.
If you have an HSA and are 55 or older, you can make an additional “catch-up” donation of $1,000 a year, and your partner can do the same, as long as each of you has your own HSA account.
Regardless of your salary, you can contribute up to the cap, and your entire donation is tax-deductible. You can also contribute during years when you don’t make much money. If you are self-employed, you may also contribute.
In 2023, the contribution cap for family health savings plans will be increased. A self-only HSA has a donation limit of $3,600.
Don’t Spend Your HSA Contributions
This may seem counterintuitive, but we’re looking at Health Savings Account as mainly an investment vehicle. To be sure, the fundamental concept behind an HSA is to provide people with high-deductible insurance plans with a tax break to help them handle their out-of-pocket medical expenses.
However, because of the triple tax benefit, the best way to use an HSA is to treat it as an investment tool that will boost your financial picture in retirement. And the easiest way to do that is to never spend your HSA contributions during your working years. Also, pay your medical expenses out of pocket.
In other words, consider your HSA investments to be untouchable before you retire, much like your contributions to any other retirement plan. Remember that the IRS does not ask you to take HSA distributions in any year, before or after retirement.
HSA Contributions Should Be Invested Wisely
Of course, the secret to optimizing your unspent contributions is to spend them wisely. Your investment policy should be consistent with that of your other retirement assets, such as a 401(k) plan or an IRA. When choosing how to invest your HSA funds, keep your whole portfolio in mind. This is so that your overall diversification plan and risk profile are where you want them to be.
How much could you Receive?
Let’s run some quick calculations to see how well this HSA savings and investment plan will pay off. We’ll use a near-best-case scenario and assume you’re 21. You make the maximum permissible contribution to a self-only scheme last year, and you contribute every year until you’re 65. We’ll assume you spend all of your contributions and immediately reinvest all of your dividends in the stock market. Thus, you’ll be collecting an annual return of 8% on average, and that your plan has no fees. Your Health Savings Account will have more than $1.2 million by the time you retire.
What about a less optimistic estimate? Assume you’re 40 years old and you only put in $100 a month until you’re 65, receiving a 3% annual return. You’d still have about $45,000 by the time you retire. To play with the numbers for your specific case, use an online HSA calculator.
Maximize Your HSA Assets
Here are some ideas about how to put your accumulated HSA investments and investment gains to use in retirement. Remember that distributions for qualified medical costs are not taxable, so use the money for those expenses only if possible. Since there are no mandatory minimum withdrawals, you can keep your money invested until you need it.
If you need to use the distributions for something else, they would be taxed. However, after the age of 65, you will not be subject to the 20% levy. Using HSA assets for reasons other than eligible medical costs is usually less damaging to your finances after you hit retirement age, and you could be in a lower tax bracket if you have stopped working, shortened your hours, or changed occupations.
Choose a Beneficiary
When you open your HSA, you will be asked to name a beneficiary to whom any funds remaining in the account should be distributed in the event of your death. If you’re married, your partner is the right person to consider because they will inherit the balance tax-free. (However, as with any investment with a beneficiary, you should review your designations on a regular basis since death, divorce, or other life changes can alter your choices.)
Pay for Medical Expenses after Retirement
According to Fidelity Investments’ most recent Retirement Health Care Expense Report, the cost of healthcare in retirement for a couple turning 65 in 2020 is $295,000, up from $285,000 in 2019. Funds saved in an HSA will help with such skyrocketing expenses.
Qualified payments on which HSA withdrawals are tax-free include:
- Copayments for office visits
- Deductibles for health benefits
- Dental charges
- Optical treatment (eye exams and eyeglasses)
- Prescription medications and insulin
- Premiums for Medicare
- Hearing aids
- Medical bills and physical therapy bills
- Walkers and wheelchairs
- X-rays
You can also use the HSA balance to pay for in-home health care, lifelong care retirement group costs, long-term care facilities, nursing home fees, and meals and lodging when receiving medical care away from home. You can also use your HSA to pay for upgrades to your house, such as stairs, grab bars, and handrails, to make it easier to use as you get older.
Often, depending on your age, there are limits on how much you will pay for long-term care benefits tax-free.
Expenses Should Be Reimbursed
For an HSA, you cannot take a distribution to compensate yourself for a specific medical bill in the same year that you incur it. The main restriction is that you cannot use an HSA balance to reimburse yourself for medical costs incurred prior to opening the account.
How do you sign up for an HSA?
To sign up for an HSA, you need to be enrolled in a high-deductible health plan (HDHP) and meet the eligibility requirements. You can sign up for an HSA through your employer or through a financial institution that offers HSAs. Some employers may offer an HSA as part of their benefits package, while others may allow you to set up an account through a financial institution of your choice.
Can you use an HSA debit card to pay for medical expenses?
Yes, you can use an HSA debit card to pay for eligible medical expenses, such as deductibles, copayments, and prescriptions. The debit card is linked to your HSA account, so you can use it to pay for expenses without having to withdraw cash from your account.
Can you invest HSA funds?
Yes, you can invest HSA funds, just like you can with a traditional savings or investment account. Some financial institutions offer investment options, such as mutual funds or exchange-traded funds (ETFs), to help your HSA balance grow over time.
How does an HSA differ from a Health Reimbursement Arrangement (HRA)?
An HSA is different from a Health Reimbursement Arrangement (HRA) in several ways. An HRA is typically offered by an employer and can only be used to pay for eligible medical expenses incurred by the employee. In contrast, an HSA is a personal savings account that belongs to the individual and can be used to pay for medical expenses incurred by the individual, their spouse, and their dependents.
What happens to HSA funds if you change jobs or retire?
When you change jobs or retire, you can take your HSA with you. Your HSA funds belong to you and are portable, so you can continue to use them to pay for eligible medical expenses, regardless of whether you are employed or not.
What is the interest rate for an HSA?
The interest rate for an HSA varies depending on the financial institution offering the account. Some financial institutions may offer interest-bearing HSAs, while others may not. You can compare the interest rates offered by different financial institutions to find the best one for your needs.
Are there fees associated with an HSA?
Yes, there may be fees associated with an HSA, such as account maintenance fees, investment management fees, and debit card fees. The fees associated with an HSA vary depending on the financial institution offering the account. You can compare the fees offered by different financial institutions to find the one with the lowest fees for your needs.
Bottom line
A health savings account, which is available to people who prefer a high-deductible health plan, has been widely ignored as an investment method. However, it offers an ideal way to save, spend, and take distributions without paying taxes due to its triple tax benefit.
When it comes to having a health care package, consider whether a high-deductible health plan is right for you. If this is the case, open a Health Savings Account and begin contributing as soon as you meet up with the requirements. You can supplement your other savings options by optimizing your contributions, saving them, and keeping the balance unchanged before retirement.
Of course, you can’t let the medical dog wag the savings tail. It is not a good idea to save your HSA funds instead of spending them on your well-being. However, if you are financially able to use post-tax dollars for current healthcare expenses while saving your pre-tax HSA dollars for later, you might amass a sizable nest egg for retirement use.
Health Savings Account FAQs
Do you lose the money in your health savings account?
With an HSA, there’s no “use it or lose it” provision. This is one of the primary differences between an HSA and an FSA. If you put money in your HSA and then don’t withdraw it, it will remain in the account and be available to you in future years.
What is special about health savings accounts?
HSAs are known for their triple tax advantage — contributions are made pre-tax, growth is tax-free and withdrawals used for qualified healthcare expenses are also are untaxed. There are some aspects of these accounts that are less well-known but might be advantageous, depending on your situation.
What’s one potential downside of an HSA?
The Cons Of Having An HSA. The biggest con of having a HSA is that you need to have a High Deductible Health Plan (HDHP) to be eligible. The HDHP needs to have a deductible of at least $1,350 for single coverage or $2,700 for family coverage. These deductible figures go up every year at roughly the rate of inflation.
What happens to HSA money if not used?
HSA money is yours to keep. Unlike a flexible spending account (FSA), unused money in your HSA isn’t forfeited at the end of the year; it continues to grow, tax-deferred. … Your HSA belongs to you, not your employer, just like your personal checking account.
