Health savings accounts can be a tool in planning for retirement health needs

Paying for health care costs is an important component in determining one’s financial needs in retirement that is often forgotten in retirement planning.  According to research by the Employee Benefit Research Institute, some couples may need $370,000 for medical expenses during retirement.  While 401(k) plans, individual retirement accounts (IRAs) and taxable investment accounts can help individuals meet their retirement planning needs, a health savings account (HSA) can provide a unique, triple tax-advantaged means of saving for medical expenses after retirement.

HSAs are a savings vehicle specifically designed to save for medical expenses that occur during working years as well as in retirement.  Contributions are made to an HSA in years where the individual is covered by a qualified high-deductible health plan (HDHP). Contributions to an HSA are based on whether the HDHP coverage is individual or family coverage.

In 2019, the maximum contribution amount is $3,500 for those with individual HDP coverage and $7,000 for those with family coverage.

What is the unique triple tax-advantage HSAs have?  An individual or his employer make contributions to the HSA and those contributions are tax deductible if made by the individual and not included in income if the employer makes the contribution.  Income earned on the amounts contributed to the HSA is also not taxed.  And finally, distributions from the HSA are free from tax if they are used to pay for or reimburse qualified medical expenses incurred after the HSA was established.

This gives HSAs an edge tax-wise against 401(k) plans and IRAs where distributions are taxed when received even if the distribution is used to pay for medical expenses.

What steps would you need to take to use an HSA to pay for health expenses in retirement?  First, you would need to be covered by an HDHP.  A HDHP pays only for medical expenses incurred after the deductible has been met, except for preventive care services which can be pay for before the deductible is met.

Your employer may offer an HDHP as part of its health insurance benefit offerings.  If your employer does not offer health insurance or if you are self-employed, you can purchase HDHP coverage on the individual market.

Next, you or your employer must contribute to the HSA.  Money that you contribute to your HSA is taken as a deduction on your tax return and contributions made by your employer are not included in your income for tax purposes.

Money contributed to an HSA is your money and it’s your account; you can use the money in that account whenever you choose – even if you are no longer working.  If you don’t use the money in the account to pay for current year expenses, that money stays in your account until you use it.

The feature of an HSA that many people overlook is that money in the account can be accumulated and put in an investment account offered by most HSA custodians.  A wide array of stocks, bonds and mutual funds are generally available through such a brokerage account.  The earnings on assets in the HSA are not taxed, which results in greater returns on the assets in the HSA.

Distributions from an HSA are not taxed if used to pay or reimburse for qualified medical expenses incurred after the HSA is established.  HSA funds can be used to pay for health insurance premiums after the HSA owner attains age 65.  This includes premiums for Medicare coverage; although, HSA distributions to pay premiums for Medicare supplement insurance policies – known as Medigap policies — would be taxable.

The HSA owner determines when a distribution is to be made from the HSA; if no distributions are taken, the assets in the account continue to grow until the HSA owner decides to take a distribution.

If the HSA owner is working and contributing to the HSA and the HSA owner does not take distributions from the HSA to pay for current medical expenses, assets in the HSA will continue to accumulate until a distribution is taken.  The HSA owner can wait to take distributions until retirement while making contributions to the HSA in each year that the HSA owner is covered by an HDHP with those contributions earning money tax-free.

While this means that the HSA owner will have to use other assets to pay current medical expenses, the long-term trade off may be worth it since the HSA owner will be accumulating assets that can be used tax-free to pay for health care expenses later in life when retired.  Compare this to contributing to a 401(k) plan or IRA in order to save for retirement, where distributions from those accounts will taxed, even though they are used to pay for medical expenses.

Many think 401(k) plans and IRAs are the only tax-advantaged means of saving for retirement.  Those who are concerned about affording health care in their retirement years may want to look into an HSA and HDHP.  For those who have enough current income to make the tax-deductible contributions to an HSA and not have to use the HSA to pay for medical expenses below the deductible, contributions to an HSA may be an excellent means of saving for medical expenses after retirement.

William Sweetnam is the Legislative and Technical Director for ECFC, a leading non-profit organization dedicated to maintaining and expanding employee benefit programs on a tax-advantaged basis.