To fund your retirement goals, you probably 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.
HSA plans: the basics.
When you open an HSA, you contribute tax-deductible dollars each year to pay for current and future healthcare costs (doctor visits, prescription medicines, etc.). 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 are not yet 65 when you start withdrawals, you will also owe a 20% penalty.
An HSA is not a “stand-alone” financial vehicle. To invest in one, you need to have a high-deductible health plan (HDHP) that meets certain requirements. For 2020, you can contribute to an HSA if you have a single health plan with a minimum deductible of $1,400 (up from $1,350 in 2019) and a maximum out-of-pocket cost of $6,900 (up from $6,750 in 2019); if you have a family health plan, HSA eligibility is based on a minimum deductible of $2,800 (up from $2,700) and maximum out-of-pocket costs of $13,800 (up from $13,500).1
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, as 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 2020, the annual contribution limit to an HSA is $3,550 for an individual and $7,100 for a family, up from $3,500 and $7,000, respectively, in 2019. If you are at least 55 years old, you can contribute an additional $1,000.2
Using an HSA for retirement.
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 70 ½. But an HSA faces no such requirement, so you can leave the money in your account to continue to grow if you choose.
- Choice of investments. Generally, your HSA starts out 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% of HSA owners keep their accounts in cash, according to the Employee Benefit Research Institute.3 This could be a mistake; if you keep your entire HSA in cash, you will greatly reduce your account’s growth potential—and you might not even keep up with inflation.
- Protection of other retirement accounts. If you were to need an expensive medical procedure, you might be forced to cash out part of your IRA or 401(k) to pay for those costs not covered by your high-deductible insurance plan. Also, you would be taking money away from those accounts 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 can 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.
- Contributions from others. Just about anyone can contribute to your HSA, including your spouse, parents, or other relatives. Conversely, you are free to contribute to the HSA of another loved one. (However, the same contribution limits apply, no matter how many people contribute to an HSA.)
As you can see, an HSA offers many attractive features when it comes to preparing for retirement. Still, everyone’s situation is different. Our team of tax-planning professionals at Leelyn Smith 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.”
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.