Looking for a way to maximize your retirement accounts while ensuring you have funds for qualified medical expenses? A health savings account, or HSA, is one of the best ways to do so. If you have an HSA-eligible, high-deductible health plan, you can take advantage of the triple tax benefits that HSA accounts are known for.
HSAs are an additional vessel for retirement savings when you have the cash flow to handle your out-of-pocket medical expenses in the years before retiring. Then, rather than withdrawing taxable IRA or 401(k) money for health expenses in retirement, you can use the funds that have been invested and accumulating in your HSA over the years.
You will not pay any tax on the earnings or withdrawals from the HSA so long as you’re making the withdrawals to cover qualified medical expenses.
How an HSA Works
To contribute to an HSA, you need to be covered by a high-deductible health plan. The minimum deductible amounts in 2023 for a plan to be considered an HDHP are $1,500 single or $3,000 family. This can be a health plan through your employer or one that you sign up for on your own.
Once you’ve opened an HSA, you can contribute from pre-tax income just as you would with an IRA or 401(k). The money grows tax-free, just like a 401(k). And, because you are making these contributions pre-tax, you reduce your overall federal tax bill.
Many people with HSAs contribute directly through payroll deductions, which can be a further advantage for contributors as there won’t be FICA taxes.
There are contribution limits on an HSA, for individuals or for households with family coverage. However, when you reach age 55, you can contribute more. In 2023, the individual contribution limit is $3,850 and the family contribution limit is $7,750. Those age 55 or older can make catch-up contributions of $1,000 annually.
If you switch employers or retire, your HSA can go with you, so there’s no fear of losing what you have put in. Unlike a flexible spending account (FSA), there is no “use it or lose it” provision with an HSA. The money in the account remains there each year, so there’s no fear of over-funding it for one year’s medical expenses.
Many HSA accounts offer investment options similar to that of your 401(k) or IRA, such as mutual funds or target date funds. We recommend maxing the contributions and investing the funds for future expenses while cash-flowing current medical expenses whenever possible.
Making the Most of Your HSA
HSAs are another way to save for your retirement goals, and they offer excellent tax advantages. They are often referred to as a “triple-tax savings” account. That’s because contributors enjoy pre-tax contributions, no taxes on earnings, and tax-free withdrawals for qualified expenses.
Retirement accounts like your traditional IRA or 401(k) have required minimum distributions when you turn age 72, wherein it is mandated that you withdraw money from the account each year and pay the associated tax. HSAs have no such required minimum distributions, which adds flexibility to your tax planning.
Thus, if you can afford to contribute, we almost always recommend that you do so. While many look at the HSA to fund medical expenses now, it’s actually a great vehicle for retirement savings. This avenue for savings and its associated tax deduction are especially important in light of the changes that came along with the SECURE Act 2.0. Starting in 2024, those who earned over $145k at their employer in the previous year must make their employer-sponsored plan catch-up contributions to Roth vs. pre-tax. Roth contributions are post-tax, so many high-earners will be losing out on a valuable tax deduction. Utilizing an HSA as a retirement savings vehicle will help to lessen or even eliminate the tax-blow from the forced shift to Roth.
As people age, their health care expenses become more complex and more expensive, so having this nest egg is very beneficial. Our Bethesda, MD fee-only financial planning firm regularly works with clients to incorporate their health savings account into their retirement planning.
Using an HSA for Qualified Medical Expenses
There are many ways to use an HSA for qualified medical expenses. Various medications—including acne and dermatology treatments, allergy medication, birth control, asthma medications, over-the-counter pain relievers, and other prescription drugs—are typically covered.
Services like chiropractic care, non-cosmetic dental care, addiction treatments, eye exams and surgeries, and even guide dogs can be eligible. Medical supplies—including breast pumps and accessories, cholesterol test kits and supplies, crutches, and canes—are also usually eligible.
Some expenses are eligible but require a letter of medical necessity, such as weight-loss programs. As for ineligible expenses, those are things like health club memberships, lotions, mouthwash, and aromatherapy. Look at the details of your HSA and work with your financial team to understand what is eligible and what is not.
Some people will use an HSA to bridge the gap between retiring before age 65 and Medicare eligibility. HSAs can be used to fund health care coverage purchased through an employer-sponsored plan under COBRA. They can also pay for premiums while you receive unemployment compensation.
Keep track of the expenses you pay for with your HSA in case you need to provide proof. Receipts, medical letters, prescriptions, and other documentation will help in the event of an audit.
Notably, HSA distributions do not have to be made in the year the expense is incurred. So long as the qualified medical expense happens after the HSA is established, you can take distributions even years into the future. This allowance makes record keeping even more vital. Your financial advisor can help you determine the best approach to using and tracking your HSA.
Other Uses for HSA Funds
Some people have low health care costs in retirement or have other ways to fund their health care. Some of these people have HSAs, which may leave you wondering what can be done with an HSA if it isn’t being spent on health care. Luckily, there are options, especially for those age 65 and up.
If you are 65-plus and have money invested in an HSA, you can withdraw it for non-medical expenses. You will have to pay income tax, just as you would with an IRA or 401(k). However, you will not have to pay the additional 20 percent penalty unless you make a withdrawal before you turn 65.
Including an HSA in Estate Planning
Another aspect of using the HSA for items other than your own qualified medical expenses is considering your estate planning. If you have money left over in your HSA account after you pass, you can plan for it to go to your heirs.
There are a few ways to get this done, and working with a professional to discuss your options can be helpful.
You can make your spouse a designated beneficiary. This means, upon your death, the HSA becomes your spouse’s. They get all the same tax benefits and advantages that you now hold.
If your spouse is not the designated beneficiary, the HSA will be converted to a taxable account. The fair market value of the account becomes taxable to the beneficiary in the year of your passing. The taxable portion can be reduced by qualified medical expenses paid for you (the decedent) by the beneficiary within a year of your death.
The other option is to name your estate as the beneficiary. This means the fair market value of the HSA is included on your final income tax return.
Your estate planning attorney and financial planner can help you determine which option is the best for you. Each has advantages and disadvantages when it comes to tax efficiency and probate.
We work with clients to decide how to maximize the benefits of an HSA as part of their ongoing financial planning. Schedule a complimentary discovery call to discuss your financial goals and how we may be able to help.
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