Are medical bills going to throw a wrench into your well-laid retirement plans?
It’s hard to predict these expenses, and recent reports about health care costs don’t exactly offer soothing news.
Even if you’re not anticipating big medical bills when you retire, the reality is that health care costs are escalating. Indeed, it’s estimated that a 65-year-old couple retiring today would need as much as $363,000 socked away to cover Medicare and Medigap premiums and out-of-pocket drug costs, according to
But there’s an increasingly popular strategy that can help you save more: taking advantage of your Health Savings Account (HSA) and its potential triple tax-free benefits.
1Source: Employee Benefit Research Institute, as of 5/16/19.
Why an HSA could become your "health care IRA"
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 their 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.
You get the ability to deduct contributions from current income, and you earn federal-tax-free growth on all interest or earnings. What makes the HSA useful for retirement saving, though, is that you can withdraw the money tax-free to pay for qualified medical expenses at any time—even if you hang onto the funds for many years until after you retire.
If that grabs your attention, here’s how HSAs work and how you can use them as a savings vehicle.
To open an HSA, you must have a high-deductible health insurance plan (with a deductible of at least $1,350 for an individual or $2,700 for a family) and, usually, no other coverage (such as Medicare).
In 2019, contributions to HSAs can total up to $3,500 for an individual ($7,000 for a family) in pre-tax dollars with additional $1,000 catch-up contributions allowed for those age 55 and older. In the case of family coverage, the spouse or other members of the family can contribute to 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 $9,000 per family if both spouses have their own HSAs 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 (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, vice president of income 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. And 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.
An increasing number of employers contribute to HSAs, similar to how they help fund retirement accounts. A survey by the Society for Human Resource Management found that more than a third of its member companies help fund their employees’ HSAs.
HSA investment options
Some financial planners call the HSA an “IRA for health care.” 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 bank savings account, others allow you to invest in offerings like mutual funds or ETFs.
One caveat: HSAs behave like IRAs in some ways, but it’s up to you to inquire about fees, costs and risks associated with these accounts.
Taxes and penalties
What if you save more money than you need for medical bills? The Affordable Care Act increased the penalties for withdrawing HSA funds for nonmedical reasons from 10% to 20%. Those penalties don’t apply if you are age 65 or older, though withdrawals for nonmedical reasons will be 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 may be able to 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.