Are medical bills going to throw a wrench into your well-laid retirement plans?
It’s hard to predict medical expenses, and recent reports about health care costs don’t exactly offer soothing news. But there’s an increasingly popular strategy that can help you save more, allowing you to take advantage of your Health Savings Account and its potential triple tax-free benefits.
Why your HSA could become your health care IRA
Even if you’re not anticipating big medical bills when you retire, the reality is that health care costs are escalating. To have enough cash to cover medical bills, a 65-year-old couple retiring now might need $213,000, according to one study by the Employee Benefit Research Institute.
The HSA was meant to help people with high-deductible health plans get a tax break to pay for current medical expenses not covered by insurance. But if you’re healthy and don’t need the money now, an HSA can be a huge help in saving for future medical costs. Besides the ability to deduct contributions, and getting federal-tax-free growth on all earnings, you can withdraw the money tax-free to pay for qualified medical expenses at any time.
Now that we’ve got your attention, here’s how you can use these otherwise ordinary accounts.
To open an HSA, you must have a high-deductible health insurance plan (with a deductible of at least $1,300for an individual or $2,600 for a family) and, usually, no other coverage (such as Medicare).
In 2017, contributions to HSAs can total up to $3,400 for an individual ($6,750 for a family) in pre-tax dollars with additional $1,000 catch-up contributions for those age 55 and older. If a family has family coverage, the spouse or other members of the family can contribute to the account set up by the family member who has the account, up to the family limit. However, you must have your own account in order to make those catch-up contributions. That adds up to a total potential contribution of $8,750 per family if both spouses have their own HSA and are over 55.
Don’t use it? Won’t lose it
Here’s the really good news: You don’t have to spend your HSA money by the end of the year or lose it—as is the case with many flexible spending accounts, or FSAs. And an HSA goes with you when you leave an employer. “It has more flexibility than an FSA, and it earns interest,” points out Rob Williams, managing director of financial planning at the Schwab Center for Financial Research. “There is no vesting process. It is your money, and you can take it with you when you leave your job.”
While you can participate in an FSA and still open an HSA, your FSA may be limited to vision and dental expenses.
As with 401(k)s, some employers contribute to HSAs; amounts vary from a few hundred dollars to more than $1,500 for a family, according to consulting firm Towers Watson.
The IRA for health care
Some financial planners call the HSA an IRA for health care (and it is treated like those retirement accounts under IRS rules). Typically, once your account holds a balance of around $2,000, you may begin to invest your savings. While some companies offer only the option of keeping your money in an FDIC-insured savings account, others allow you to invest in offerings like mutual funds or ETFs.
One caveat: HSAs behave like IRAs in some ways, but they aren’t subject to the same level of scrutiny. The Employee Retirement Income Security Act (ERISA) disclosure rules that govern 401(k)s, for example, don’t apply to HSAs, so it’s up to you to inquire about fees and costs and risks associated with these accounts.
On the upside: Your allowable HSA contributions have no bearing on your 401(k) or IRA contributions; you can max out all three savings vehicles if you’re able.
Taxes and penalties
What if you save more money than you need for medical bills? The Affordable Care Act increased the penalty tax for withdrawing HSA funds for nonmedical reasons from 10% to 20%. But if you are age 65 or older, there’s no penalty on withdrawals for nonmedical reasons. However, the money you take out is taxed as ordinary income, similar to a traditional IRA.
If you die with money still in your account, you can leave those savings to your spouse (who can use the money free of estate taxes, and tax-free for medical expenses). Your other heirs, however, would pay tax on the money they inherit.
But assuming you might need extra money for medical or long-term-care bills as you age, using your HSA as a savings cushion could be one of the smartest tax-free moves you can make.