By Dan Drallmeier, CFP®
Many people know the basics about how a 401(k), IRA and Roth IRA can benefit them in saving for the future but what if we told you there is another account that isn’t as widely known with more tax benefits than any other retirement account. Are you intrigued? The type of account in question is a Health Savings Account (HSA). In this article, we will explain how HSAs work, including who is eligible and how to maximize such accounts for your future by turning one into your “medical piggy bank.”
What Is an HSA?
An HSA is a tax-deductible health care savings account that is available to anyone who has a high deductible health plan (which means that your deductible is at least $1,350 for individuals or $2,700 for families).1 The maximum annual contribution in 2019 between you and your employer is $3,500 for individuals and $7,000 for families.2 The account is in your name, so there is no “use it or lose it” issue like there is with some other accounts like FSAs. In most cases, you can invest the account to allow for future growth, which makes it a very powerful tool for retirement planning and allows you to build up funds for health care expenses before and during retirement.
What Can the Funds Be Used For?
- Some health insurance, coinsurance and deductibles
- Most medical, dental and vision expenses
- Prescription drugs
- Medicare premiums
- Some long-term care policy premiums
- A more complete list
Why Should I Be Maxing out My HSA?
The HSA is the only triple tax-advantaged account, which makes it the most tax-advantaged account in which you can save and invest. First, you get a current year tax deduction for your contribution plus your account can be invested and grow tax free. Finally, if the funds are used for approved medical expenses, then the withdrawals are tax free. So, this account acts like a traditional 401(k) (tax-deductible contributions) when you make contributions but acts like a Roth (tax-free withdrawals) when you take out money for medical purposes.
How Can Individuals Maximize the Benefit of Their HSA?
If individuals have the cash flow to allow it, they should make the maximum contribution to their HSA, invest as much of the account as their provider allows and pay for their medical bills out of pocket (keeping detailed records/receipts of medical expenses). This leaves the HSA funds invested and growing tax free, which then becomes a “medical piggy bank.” It is critical to have enough savings to cover medical expenses in retirement, as a recent study from Fidelity points out.3 According to the study, the average couple will need $280,000 for medical expenses in retirement not including long-term care and that is in today’s dollars, which doesn’t even factor in rising health care costs.4 But with an HSA (assuming an 8% annualized return), one year’s contribution of $3,500 would grow to about $35,000 in 30 years, which is a great start for retirement medical savings. As an added bonus for those inclined, at any point, you can reimburse yourself for medical expenses that you paid out of pocket as long as you keep those records. This means that a doctor’s bill for $100 from when you were 30 years old can be reimbursed to you from the HSA 30 years later after you have allowed the account to compound significantly. You are paying past expenses with cheaper future dollars.
What if I Have a High Deductible Health Plan but I Do Not Have Access to an HSA Through My Employer?
Employers are not required to give access to an HSA even if they have a high deductible health plan available. Check with your employer to find out if the plan has an HSA that you can set up. If not, you can set up one individually with many different providers. First, talk to your financial advisor who can help you with this process. Two providers that we suggest due to relatively low fees, diverse investment options and decent user interface are livelyme.com and healthsavings.com.
A Few Additional Points
- High deductible health plans usually have lower premiums than their counterparts.
- Some employers will make contributions to HSAs on an employee’s behalf.
- Individuals can use HSA funds penalty free for non-medical expenses after age 65 but they will be required to pay income tax on the distributions just like for pretax traditional IRAs.
- HSA funds can still be used if an individual does not have a high deductible health plan, but he or she can no longer make contributions.
- If the owner of the HSA account dies, his or her spouse can inherit and continue to use the funds for medical purposes. For non-spousal beneficiaries, the entire inherited balance is taxable as income (less any medical bills received for the deceased within one year of death).
Note that this article quotes 2019 announced limits that are subject to change as well as are generally increased over time. HSA rules are defined by the IRS. You can find additional information here: https://www.irs.gov/publications/p969
. Talk to your financial advisor today to see if saving into a Health Savings Account combined with a high deductible health plan is right for you.