To fund your retirement goals, you likely will need to draw on a variety of income sources, including your 401(k), IRA, brokerage accounts, and Social Security. But you might be overlooking another possibility: a health savings account (HSA). As the name suggests, an HSA is used to pay for healthcare—but it can also play a valuable role in supporting your retirement goals.
HSAs: the basics.
When you open an HSA, you contribute tax-deductible dollars each year to pay for current and future healthcare costs (e.g., doctor visits and prescription medicines). Unlike flexible spending accounts, HSAs are not a “use it or lose it” proposition. Unused amounts in any given year will stay invested and continue to grow tax-free, assuming you eventually use the money for qualified medical costs.
Withdrawals for non-medical costs will be taxed at your normal tax rate; if you aren’t yet 65 when you start withdrawals, you will also owe a 20% penalty.
An HSA is not a standalone financial vehicle—to invest in one, you need to have a high-deductible health plan (HDHP) that meets certain requirements. For 2022, you can contribute to an HSA if you have a single health plan with a minimum deductible of $1,400 and a maximum out-of-pocket cost of $7,050. If you have a family health plan, HSA eligibility is based on a minimum deductible of $2,800 and maximum out-of-pocket costs of $14,100.
An employer-sponsored HSA typically works like a traditional 401(k): You make pre-tax contributions, and your employer may match part of them. And your HSA is “portable”—you can leave your employer and still keep your account intact.
But even if you are self-employed, or you work for a business that doesn’t offer health insurance, you can get an HSA as long as you also have an HDHP. You can find this type of plan on Healthcare.gov, among other sources. Make sure the plan is HSA-eligible, because some are not. Keep in mind that to participate in an HSA, you can’t have other medical coverage, such as Medicaid, Medicare, or a Flexible Spending Account (FSA) through your spouse’s plan. In any case, if you do have an HSA on your own, you will still get the tax break by claiming your contribution as an “above the line” deduction.
In 2022, the annual contribution limit to an HSA is $3,650 for an individual and $7,300 for a family. If you are at least 55 years old, you can contribute an additional $1,000.
Using HSAs for retirement savings.
Although HSAs are designed to support healthcare spending, they can be viewed as a tool for supplementing your retirement savings. This is especially true if you have maxed out your contributions to tax-advantaged retirement accounts such as an IRA or 401(k) and have additional cash that you are looking to put toward your anticipated spending needs in retirement.
Using an HSA to supplement your other retirement accounts offers several potential advantages:
- Tax benefits. Your HSA essentially offers three tax benefits. First, you typically fund it with pre-tax dollars, so the more you put in, the lower your tax bill. Second, your earnings will grow tax-free. And third, your withdrawals are tax-free, provided they are used for qualified medical expenses. So, if you had the assets available, you could pay your non-covered healthcare bills out of pocket and let your HSA balance grow, eventually using the money for retirement. (Once you’re 65, you can take withdrawals from your HSA without paying the 20% penalty, though the money will still be taxed as ordinary income.)
- Offset of medical costs. You can’t contribute to an HSA once your Medicare coverage begins, but you can use your HSA to offset medical costs in retirement—and these costs are often the biggest expense faced by retirees. You can even use your HSA to pay Medicare premiums.
- No RMDs. With a 401(k) and a traditional (non-Roth) IRA, you will have to start taking taxable withdrawals—technically called “required minimum distributions,” or RMDs—once you turn 72. But an HSA faces no such requirement, so you can choose to leave the money in your account to continue growing.
- Choice of investments. Generally, your HSA begins as a cash account, earning interest like a savings account. But once you attain a certain balance, you can convert the HSA into an investment account. Your HSA provider will offer several investment options, allowing you to build a portfolio that reflects your long-term goals and risk tolerance. However, 96 percent of HSA owners keep their accounts in cash, according to the Employee Benefit Research Institute.This could be a mistake; if you keep your entire HSA in cash, you will greatly reduce your account’s growth potential—and you may not keep up with inflation.
- Protection of other retirement accounts. If you were to require an expensive medical procedure, you might be forced to cash out part of your IRA or 401(k) to pay for costs that aren’t covered by your high-deductible insurance plan. In addition, you would be taking money away from those accounts that are designed to help you retire comfortably. As an alternative, you could use your tax-free HSA funds to cover the costs.
- Possible receipt of lump sum. Taking full advantage of your HSA may require some bookkeeping on your part. But if you save your receipts for out-of-pocket medical expenses in the years before you sign up for Medicare, you can use your HSA to pay yourself back, giving you a tax-free lump sum in retirement.
As you can see, an HSA offers many attractive features when it comes to preparing for retirement. Still, everyone’s situation is different. Leelyn Smith’s team of tax-planning professionals can help you determine if an HSA is appropriate for your needs, and, if so, how you can best put it to use to make your retirement savings even healthier.
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