Saving money is often mentioned as one of the essential steps to financial success. It is also important to decide or to save money, as there are many options to consider. 401(k)s, IRAs, Roth IRAs, non-qualified accounts and others all have their own rules, benefits and tax implications. Of all these accounts, however, there is one account that may be the most valuable and, at the same time, the most overlooked: the Health Savings Account (HSA).
An HSA is a tax-efficient way to save money to pay qualified medical expenses. It’s available to people covered by a high-deductible health insurance plan, and like 401(k)s and IRAs, HSAs have contribution limits set each year. While many high-income earners may find themselves ineligible for a Roth contribution or IRA deduction, HSAs have no income limit on who can contribute.
Since it’s only available to those with high-deductible health plans, you should first make sure which type of health insurance best suits your situation. Ideally, high deductible plans are for people with low health care needs, and since your health may one day dictate that a high deductible plan is not in your best interest, it is all the more important to take full advantage of an HSA while you can.
When people think of the HSA, they rarely think of retirement savings. Often, it is instead used as a source of funds for current health care costs to be withdrawn and spent each year. This can lead to a significant missed opportunity. Unlike a Flexible Spending Account (FSA), where funds must be spent by the end of the year, HSAs allow account balances to be carried forward to future years. For this reason, along with the tax advantages and flexibility that an HSA offers, it becomes an ideal long-term investment account. Being more specific, the HSA becomes a perfect account to consider as a medical retirement plan.
The HSA offers unparalleled tax benefits
A major feature of the HSA that sets it apart from other accounts is its tax advantages. Many of us are familiar with the tax savings that come with 401(k) contributions. Contributions are tax deductible, which allows us to realize tax savings in the years in which 401(k) contributions are made. This tax incentive is offered, in part, to encourage people to set aside enough money for their retirement. Similarly, investments promote economic growth. Therefore, as a matter of policy, the federal government offers many tax incentives to encourage people to save.
Various accounts, particularly retirement accounts, offer some form of the following: tax deduction on contributions, tax deferral on growth, and/or tax-free withdrawals. Annuities, for example, offer tax-deferred growth, while most retirement accounts offer a combination of two of the three forms.
Surpassing all of this, the HSA offers triple tax benefits:
- Tax deductions on contributions.
- Tax-deferred growth.
- And tax-free withdrawals if used for eligible medical expenses.
Adding all of these together can result in significant tax savings and more money in your pocket. These tax savings would be maximized by investing contributions for growth and not withdrawing them immediately for ongoing medical expenses. When withdrawn immediately, the account loses one of its three tax benefits, as it is denied the opportunity for tax-deferred growth.
To get an idea of the potential savings, compare an IRA and an HSA, which have — until the time of withdrawals — enjoyed the same tax benefits. At the time of withdrawals, this changes as the IRA money is now taxed while the HSA is tax exempt. If both accounts were $300,000 and the owner was in the 24% tax bracket, the after-tax equivalent at that time for the IRA is $228,000 ($300,000 – 24% tax) while the HSA has an after-tax equivalent of $300,000. This leaves $72,000 in additional tax savings due to the triple tax advantage of the HSA versus the double tax advantage of the IRA.
The HSA is flexible
In addition to great tax advantages, HSAs, in many cases, also offer the best flexibility. One reason is that HSAs have no limits on when a health care expense is incurred and when it is reimbursed. Instead of withdrawing money from the HSA at the time of each medical expense, you can use money to pay medical bills and let the HSA continue to grow. This allows you to maximize tax benefits by keeping money in the tax-efficient HSA account.
You should then keep these medical receipts, as the HSA can be tapped at times when available money can become tight. Since medical expenses can be reimbursed later, if you need money for your living expenses, you can take it out of your HSA by using it to reimburse yourself for one of those previous medical expenses. For most retirement accounts, withdrawing money in a cash crisis is usually done either by accepting a 10% early withdrawal penalty, withdrawing Roth IRA contributions, or taking out a loan on your 401(k). ). For HSA, funds are available before age 59.5 if used for eligible medical expenses.
Adding to the flexibility, the list of medical expenses that the IRS considers “qualified” is long. It includes things like doctor visits, dental checkups, lab fees, and physiotherapy. Other common eligible medical expenses include long-term care premiums (up to a certain amount each month depending on your age) and Medicare A, B, C, and D premiums. Note that additional Medicare premiums, such as Medigap, however, are not eligible.
The Medical Retirement Account
To get the most benefits from an HSA, it’s best to think of it as a long-term investment vehicle to help cover future medical expenses in retirement. It may be a missed opportunity not to approach it as such. This includes maximizing and investing contributions for growth, paying current medical expenses out of pocket, and keeping receipts so you have the ability to withdraw funds if life upheavals lead to temporary hard times. .
Positioning the HSA as a medical retirement plan will provide you with an important tool to manage health care costs in retirement, which we will all have to some degree. As already mentioned, one of them is health insurance premiums. In fact, Fidelity estimates that the average couple will need $300,000 in today’s dollars for medical expenses in retirement. The HSA may be there, offering tax-free withdrawals for these fees.
And, although the HSA has a 20% penalty if the funds are withdrawn and not used for eligible medical expenses, after age 65 this penalty decreases. So if you find yourself over 65 and in a situation where you have to tap your HSA and you don’t have enough medical expenses, the HSA can prove itself again because withdrawals are taxed but not penalized. In other words, you still receive the tax-deferred contribution from previous years and all tax-deferred growth, while only losing the tax-free withdrawal — similar to the tax benefits of an IRA. The HSA, in this situation, now acts like an IRA for tax purposes, though, which makes it even better, one that has no required minimum distributions.
In summary, with all the benefits of an HSA, it can be a great option for retirement medical expenses. Because you must have a high-deductible health insurance plan to qualify for an HSA, and such a plan may not always be the best fit for your medical condition, it is important to take advantage of the HSA when you can. In return, you get triple tax benefits, flexibility to access it for qualifying medical expenses without penalty before retirement, and worst-case scenario – after age 65 it becomes, for all intents and purposes, an IRA. with no minimum distributions required. .
Financial Advisor, Kehoe Financial Advisors
Kevin Webb is a Financial Advisor, Insurance Professional and Certified Financial Planner™ with Kehoe Financial Advisors in Cincinnati. Webb works with individuals and small businesses, providing comprehensive financial planning, including social security strategies, as well as tax, retirement, investment and estate advice. He is a fiduciary, making sure to act in the best interests of his clients.