Saving for Health Care in Retirement

Why It Matters:

  • A health savings account (HSA) can be used for more than just paying today’s medical costs.
  • With an HSA, money goes in pretax and can come out tax free.
  • Savings in an HSA can be invested.

Chase Squires tkc.profilePicture Written by: Chase Squires | Transamerica
Sept. 19, 2017

3-4 Min readClock Icon

Earning money on investments is good. Earning tax-deferred money on investments is even better.

How about earning tax-free money?

Savers can use individual retirement accounts (IRAs) and workplace tax-deferred savings accounts such as a 401(k) to sock away money for retirement. But there are limits.

For people with a high-deductible health plan, there could be another tax-advantaged way to save, the health savings account (HSA). HSAs can be sort of like an IRA for health care but a little better. Money goes in before income taxes are taken out of it. It grows tax free. And if it’s used for qualified medical expenses, it comes out tax free. That’s a triple tax advantage.

A recent Kaiser Family Foundation study found high-deductible plans are becoming more common, so even if you weren’t eligible before, you may be now. In 2016, 29% of workers were in such plans, up from 20% in 2014.

You can use money from an HSA account at any age to pay qualified medical costs.

Or you could go ahead and pay those medical deductibles and copays out of pocket during your working life instead of tapping your HSA. If you can afford those costs while you’re working, you can leave your HSA untouched and let it grow, tax deferred, throughout your career. Then in retirement, after age 65, you can take it out for anything and only pay ordinary income tax, just as you would with an IRA or workplace retirement plan.

The catches

Of course, the generosity of the government has limits. There are rules to stashing money in an HSA:

1. You must qualify. Important requirements include:

  • You must be in a high-deductible health insurance plan (HDHP). For 2017, that’s a plan with a deductible of $1,300 or more for an individual, $2,600 for a family plan. (Oh, and you can’t be enrolled in another plan that is not an HDHP or provides coverage for a benefit that is covered by the HDHP). Each year, these limitations can be adjusted for a cost of living increase. In 2018, these amounts increase to $1,350 or more for an individual, $2,700 for a family plan.
  • Additionally, a high-deductible plan can’t require that you have more out-of-pocket expenses under the plan than $6,650 for individuals and $13,300 for a family.
  • Failing to meet the above requirements or any other requirements needed to qualify means that your HSA contributions will be taxable. Plus, any tax you owe will be increased by an additional 10%. So be careful.

2. Once it’s in, it’s in. If you put money into an HSA, you’ll pay income tax plus a hefty 20% penalty if you take it out for anything other than qualified medical expenses (generally, until you’re 65). That’s double the penalty for early IRA withdrawals.

3. There are limits. You knew the government wouldn’t let you keep unlimited amounts of income out of its mitts. The most you can put into an HSA in 2017 is $3,400 for individuals, or $6,750 for family coverage. These limitations are also subject to a cost of living index, so, in 2018, the limits are $3,450 for individuals, or $6,900 for a family plan. Individuals who are 55 and older are also allowed to make an additional annual catch-up contribution of $1,000. Current rules do not change the catch-up contributions from year to year. The amount you are allowed to contribute may also be limited by other factors, such as contributions made to another HSA and the number of months you were enrolled in an eligible insurance plan.

4. If you go overboard. If you contribute more than the allowable amount into an HSA, you will have to pay ordinary income tax on the excess plus a 6% excise tax. This can trip you up if you change jobs mid-year or otherwise change insurance plans from an eligible high-deductible plan to a plan with lower deductibles. Some employers contribute to employee HSAs. That company contribution counts toward the limit. If you mistakenly contribute too much, you can avoid a penalty by taking the excess out and report it as income – and take note of any gains that excess may have generated – before you file your taxes.

Why save in an HSA?

An HSA is yours to keep. It’s not to be confused with the workplace flexible spending account (FSA) that sets aside “use it or lose it” money for health and dependent care you must use in the year you set it aside. The HSA is your money. Even if you change health plans and don’t qualify to make new contributions, you can leave your HSA account money where it is. In fact, if your company offers a qualifying high-deductible plan but no HSA, you can set one up yourself.

And, like an IRA, you can invest your savings inside the HSA. A financial professional can help you decide what strategies are right for you. Every situation is different.

What if you save throughout your career, then don’t have a lot of medical expenses in retirement? (Good luck with that: The government reports those 65 and up spend on average $5,994 a year on health care.) Consider most people today pay about $109 in monthly premiums for Medicare Part B (that’s the part that covers doctors). And that cost may go up. Most 65-year-olds joining Medicare in 2017 will pay the standard cost of $134 a month (consider 12 x 134 = $1,608 per person).

An HSA can even be used to pay those Part B premiums (but not Medigap coverage). So even a healthy 65-year-old will have a monthly qualifying medical cost if they are on Medicare.

If you think savings and investments won’t add up, consider the effect of compound interest. In a hypothetical example, imagine a 35-year-old who contributes $3,400 a year to his HSA until he’s 65 (assume he doesn’t add the $1,000 catch-up and the IRS doesn’t raise the contribution limit, even though it does sometimes). With a modest 4% average annual return, he would hypothetically have more than $200,000. Of course markets can also go down, so you may want to ask about investment risks.

If spent on qualified health care, the principal and gains (if any) aren’t taxed.

Want to know more? Consult a financial professional, and check out the IRS’ surprisingly easy-to-read publication on HSAs.

Neither Transamerica nor its agents or representatives may provide tax, investment, or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors and financial professional regarding his or her particular situation and the concepts presented herein.

Things to Consider:

  • Ask your financial professional if an HSA is right for your situation.
  • Before spending HSA savings on today’s medical expenses, consider if you’d rather leave those savings invested.
  • HSA-eligible health plans are becoming increasingly common.

Photo: TWENTY20.COM/makenamedia

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