A common concern we often hear from a person who is contemplating retirement is how to pay for the rising costs of healthcare when the paychecks stop. And this concern is valid! The Baby Boomer generation is living longer, more active lives than any previous generation, and along with an extended advanced age comes the increased probability of requiring more and more medical services. According to Fidelity's latest estimates, a 65-year-old couple retiring this year can expect to spend $285,000 on medical expenses alone throughout retirement!
One way to plan for these expenses in retirement is via a “Health Savings Account”, or HSA. An HSA is a tax-advantaged savings/investment account designed to help save for medical expenses. To qualify, you must have a high-deductible health insurance plan, defined as an annual out-of-pocket deductible of $1,350 for single coverage, or $2,700 for family coverage. If you meet that eligibility requirement, you can contribute up to $3,500 for individual coverage and $7,000 for family coverage this year, keeping in mind that these limits can change from year to year. If you're 55 or older, you can also make an additional $1,000 catch-up contribution. In order to make this a retirement healthcare savings account, it would require you to make the contributions during your working years (starting the earlier, the better) and then not use them to pay for many of your medical expenses until you retire, letting your contributions grow and grow. (Unlike Flexible Spending Accounts or FSAs, HSAs do not need to be used up in the year of contribution, but can be carried forward indefinitely.) In fact, the whole point of an HSA is to invest your money so that once retirement rolls around, you'll be sitting on a hefty balance to tap.
- HSAs are triple-tax-free
You're probably aware that when you fund a traditional IRA or 401(k), that money goes in on a pre-tax basis. Your money then gets to grow tax-deferred so that you're not paying taxes on investment gains year after year, but once you take withdrawals in retirement, you're subject to taxes. HSAs, on the other hand, are triple-tax-free: Contributions go in tax-free, your money grows tax-free, and withdrawals are taken tax-free provided they're used to cover qualified medical expenses. How's that for savings? Sounds almost too good to be true, right? Here is something to be aware of however: if you take distributions before age 65 for non-qualified expenses, you’ll be hit with a 20 percent penalty and pay income tax. And, to clarify, you can withdraw money after age 65 for non-medical expenses, with no penalty, but the distribution will be subject to income tax.
- Help with Long Term Care Insurance and Medicare Expenses
You can’t make new contributions to an HSA after you enroll in Medicare, but you can continue to use the money that’s already in the account tax-free for out-of-pocket medical expenses and other eligible costs that aren’t covered by insurance, such as vision, hearing and dental care and co-pays for prescription drugs.
You can also take tax-free withdrawals to pay a portion of long-term-care insurance premiums based on your age, and after you turn 65, you can use HSA money to pay premiums for Medicare Part B, Part D or Medicare Advantage. However, you CANNOT use your HSA to pay for Medicare Supplement Plan premiums.
3. HSAs don't have required minimum distributions
The money you save in a traditional IRA or any type of 401(k) can't just sit there indefinitely. Once you turn 70-1/2, you'll need to start taking mandatory withdrawals annually known as required minimum distributions, or RMDs. In doing so, you lose out on the tax-advantaged growth you were previously getting on that money. HSAs, however, don't impose RMDs, so if you don't have a need for your money every year in retirement, you can leave your balance alone to grow for larger expenses that might loom.
- HSAs can be funded by employers, too
Many employers who sponsor 401(k) plans also match employee contributions to varying degrees. Thankfully, this benefit exists for HSAs as well. If your company is so inclined, it can contribute money to your account (though employer contributions do count toward the annual limit). Also, if you have an eligible high deductible health insurance plan, you can open a Health Savings Account on your own at a bank or a brokerage firm if it is not offered through your workplace.
- There are no income limits associated with HSAs
Higher earners are often barred from capitalizing on certain tax breaks. For example, many tax credits phase out for higher earners, and those with substantial incomes are also prohibited from funding Roth IRAs. The good thing about HSAs is that there are no income limits to worry about. As long as you stick to the annual contribution limits, you're free to participate in an HSA regardless of how much money you make.
The Bottomline: If you're worried about affording healthcare in retirement, start looking into a health savings account. It is an opportunity to save additional monies and get a tax deduction, possibly receive an employer contribution as well and build an investment account that can be used tax free for medical expenses in retirement! If you would like to learn more, please contact us!
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.