The IRS recently announced the 2023 Annual Cost of Living Adjustment to the maximum contribution that can be made to Health Savings Accounts, or HSAs, for eligible individuals covered by high-deductible qualifying health insurance. The 2023 limits have been increased to $3,850 for personal coverage and $7,750 for family coverage.
These adjustments are about four times larger than they were from 2021 to 2022, and with inflation currently skyrocketing, future adjustments are expected to be even larger. Additionally, for those age 55 or older, an additional $1,000 may be contributed.
For years, in my experience as a tax practitioner, most of my clients who had an HSA used them primarily as a funnel to just pay routine medical expenses with pre-tax money. In other words, they would make current contributions to the account roughly equal to their medical expenses for the year, take the corresponding tax deduction, and then withdraw the funds from the account to reimburse themselves for the medical expenses incurred, leaving little behind in the account.
Nothing necessarily wrong with this approach, as it at least saves on the income tax bill. But consider this — according to one source, Fidelity’s Retiree Health Care Cost Estimate, an average retired couple turning 65 in 2021 might need about $300,000 in after-tax funds to cover their expenses. retirement healthcare costs (the 2022 estimate has not yet been released but no doubt it will be larger).
Given the estimate above and the longer-term tax advantages of an HSA compared to other investment and retirement savings vehicles, the “funnel” approach mentioned above may be short-sighted, leaving valuable financial benefits on the table that could go a long way to covering medical expenses during retirement.
Many people mistakenly think that HSA funds should simply be held in a low interest bank account, but this is not the case. On the contrary, an HSA can be invested for a longer term in stocks, bonds, mutual funds, etc., just like other investment and retirement accounts.
Admittedly, like any investment vehicle, there is investment risk, as assets are subject to market volatility. They can go up in value (as they tend to do historically over time), but they can also go down in value, as we see with recent market sell-offs (which some see as an opportunity to buy stocks, as they say, “oversell”).
But if the long-term goal is financial security in retirement, and a subset of that goal is having enough to pay your medical bills, investing fully where possible using an HSA has a lot going for it. sense given its inherent advantages.
First of all, as already mentioned before, contributions to an HSA are tax deductible, unlike funds placed in a typical savings or investment account. So right off the bat, you have more money left in your pocket to save in other ways or for your day-to-day expenses.
Once in the account, any income earned or growth in the value of investments is not subject to income tax and will never assume that it is then used to pay or reimburse you for eligible medical expenses incurred.
Also, HSAs have an advantage, at least in my mind, that trumps all types of IRAs in that an HSA in a sense combines the best of a traditional IRA and a Roth IRA. What do I mean by that?
With a traditional IRA, when you make a contribution, you get a tax deduction just like you do with an HSA, that is, assuming the deduction is not limited by your income. However, when the funds are withdrawn, the distribution is taxable income to you and, if withdrawn before age 59.5, is subject to an early withdrawal penalty. A Roth IRA, on the other hand, does not provide a deduction when funded, but in most cases withdrawals are tax-free, including income.
The HSA, being the best of both worlds, gives you the initial deduction of a traditional IRA (without the income limits), the tax-free growth while in the account is the same as both types of IRAs. , and the tax-free withdrawal nature of a Roth IRA when used for medical expenses, making it an excellent, viable investment vehicle to prepare for retirement.
Flexibility, tax advantages, and long-term financial planning focused on medical expenses at retirement age make health savings accounts, if you qualify for one, a potentially powerful weapon in your arsenal. retirement planning.
