You may be familiar with Health Savings Accounts (HSAs) as a way to cover healthcare costs with pre-tax dollars. But this tax-efficient savings vehicle can also be used as a powerful tool for retirement savings. Because an HSA is one of the most tax-efficient savings options available, consider contributing the maximum amount to your HSA and paying for current health care expenses from other sources of money.
Not all medical insurance plans allow you to have an HSA. To use an HSA with your health insurance plan, you need to enroll in a “Qualified High Deductible Health Plan”, also known as an HSA-compatible health plan. In 2024 a high deductible plan was defined as:
Having annual deductibles of at least $1,600 for self-only coverage and $3,200 for family coverage; and
Maximum out-of-pocket medical costs do not exceed $8,050 for self-only coverage and $16,100 for family coverage.
You can save in an HSA if you are enrolled in an HSA-eligible health plan at work or in the private and public marketplaces. Most people think of HSAs as a way to save to cover current medical costs not covered by such plans. But if you can pay for these costs out-of-pocket, the triple tax-free nature of an HSA makes it a powerful vehicle for retirement savings.
For 2024, The IRS contribution limits for HSAs are $4,150 for individual coverage and $8,300 for family coverage. If you’re 55 or older during the tax year, you may be able to make a catch-up contribution, up to $1,000 per year. Your spouse, if age 55 or older, could also make a catch-up contribution, but will need to open their own HSA.
Many people contribute to HSAs pre-tax through payroll deductions at work, so their contributions also escape FICA taxes. As long as you are enrolled in a health plan that qualifies, you can also open an HSA outside of work and fund it with after-tax dollars, which you then may take as a tax deduction on your personal taxes. These contributions can accumulate tax-free and can be withdrawn tax-free to pay for current and future qualified medical expenses, including those in retirement. If you are no longer covered under a qualifying plan, you can’t continue to make contributions, but you can still hold the account and your previous contributions can continue to grow tax-free.
Unlike most Flexible Spending Accounts (FSAs), the money in an HSA does not have to be spent by the end of the calendar year and can remain in your account from year to year. You can earn interest or earnings on your HSA, and you can take it with you should you switch employers or retire.
As mentioned at the opening of this article, because an HSA is one of the most tax-efficient savings options currently available, you may want to consider contributing the maximum allowed and paying for current health care expenses from other sources of personal savings and don’t tap into it, unless necessary.
Many save for their children’s college expenses in a specialized 529 savings account. Now think about health care. You’ll likely face a bevy of health care expenses in your future—medical procedures, hospital bills, prescription drugs, maybe even home health care or nursing home expenses. No one knows when these expenses will hit, or how much you may have to pay.
Since you will likely have to pay for large scale health care expenses sometime later in life, building a nest egg specifically designed to help cover future health care costs is a prudent move. But how much should you save?
According to the Fidelity Retiree Health Care Cost Estimate, an average individual may need $157,500 (after tax) to cover health care expenses in retirement. an average retired couple age 65 in 2023 may need approximately $315,000 (after tax) to cover health care expenses in retirement.
Although health care costs continue to rise, there are ways to get ready for medical expenses that might come in retirement. But you’ve got to save early and put those dollars to work by investing them. If you think you might need to use some of your HSA for near-term medical expenses, set aside some of your HSA in a cash account to cover them, and invest the rest for tax-free growth and to help fortify your retirement.
How do HSAs compare to other savings vehicles? The tax treatment of HSAs provides the potential for greater investment growth and greater after-tax balance accumulation than other retirement or health care savings options. Assuming you use HSA funds to pay for qualified medical expenses, you do not pay any federal taxes. That’s why it’s at the top of the list for tax-efficient investment options for your retirement.
While you can’t pay premiums for all types of health insurance coverage using HSA money, you can use HSA funds to pay for qualified medical expenses such as deductibles, copays, and coinsurance. (Not all medical expenses are considered qualified by the IRS.)
You can use your HSA to pay certain Medicare expenses, including premiums for Part A (if applicable), Part B and Part D prescription-drug coverage and Medicare Advantage, but not supplemental (Medigap) policy premiums. For retirees over age 65 who have employer-sponsored health coverage, an HSA can be used to pay your share of those costs as well.
Your HSA can also be used to cover part of the cost for a “tax-qualified” long-term care insurance policy. You can do this at any age, but the amount you can use increases as you get older.
Once you hit 65, you can use your HSA to pay for any non-qualified medical expenses (including buying a boat, for example), but you don’t get to take full advantage of the tax savings as you will be required to pay state and federal taxes on those distributions. If you are under age 65, you pay a 20% penalty on nonmedical withdrawals, and you pay ordinary income tax in addition to the penalty, so be careful!
In the event that your medical expenses are much lower than average (or you don’t live that long), you may have money in your HSA that you can pass along to your heirs. The rules are complicated so it’s best to consult an estate planning attorney. There are generally three categories to consider when determining how HSA assets are treated upon your death:
Many people prefer to name the surviving spouse as the designated beneficiary. However, if you don’t have a surviving spouse, the primary planning consideration could be tax-efficiency. In that case, consider naming as beneficiary (either your estate or beneficiary), whichever party is in the lowest tax bracket. If you name your estate as the beneficiary of your HSA, it will likely become a probate asset and it still needs to fit in with your overall estate plan. Work with your tax and estate planning professionals to determine which option is right for you.
Typically, once you turn 73, you will need to take required minimum distributions from traditional IRAs and 401(k)s, and you would have to pay taxes on those distributions. HSAs have no required minimum distribution.
There are a lot of ways to make HSAs work for you—whether you are still employed, getting ready to retire, or even retired and enrolled in Medicare. To get started, contact us by clicking here.
