QUESTION: What is a health savings account and how can it be used before and after retirement?
ANSWER: A health savings account is designated to pay out-of-pocket medical expenses with pre-tax dollars. By using untaxed dollars for deductibles, copayments, coinsurance and certain other medical expenditures, the account holder can reduce overall health care costs.
HSAs are most beneficial for individuals with a high-deductible health plan to pay expenses not covered by insurance. There were about 21.4 million high-deducible plan holders in 2017, according to a Devenir HSA Market Survey.
In 2020, the allowable tax-exempt annual health savings account contribution was $3,550 for individual coverage and $7,100 for family coverage. In 2021, allowances increased to $3,600 and $7,200, respectively. According to an Employee Benefit Research Institute report, the average HSA balance was $3,221 in 2019.
HSAs have tax advantages that can make them a superior means for retirement savings. In fact, it is a triple tax advantage.
Like 401k plans or traditional IRAs, HSA contributions are tax deductible as they are made. Also, HSA withdrawals are tax free, like a Roth IRA.
“(HSAs are) the most tax-preferred accounts available. Using one to save for retirement medical expenses is a better strategy than using (other) retirement accounts,” according to Michael Kitces, director of financial planning at Pinnacle Advisory Group.
Since HSA contributions are pre-tax dollars, these deposits can reduce federal income tax liabilities and are not subject to FICA taxes, even if you do not itemize, according to the IRS.
Generally, pre-retirees likely are more familiar with 401k, IRA or other workplace defined contribution retirement plans. Uunlike other retirement accounts, an HSA does not require the account holder to begin withdrawing money at a certain age.
Also, HSAs are fully portable and can move with the account holder to a new job since it is not held by the employer.
HSA balances can be carried over from year-to-year since there is no “use it or lose it” requirement; unlike a flexible spending account, which are savings with specific tax advantages to reimburse an employee for qualified medical and dental related expenses. Up to $500 of unused FSA dollars can roll-over to the next year, according to U.S. Treasury Department information.
HSA balances can remain on deposit indefinitely, although additional contributions are not allowed once the account holder reaches age 65, enrolls in Medicare Parts A and B and receives Social Security.
Before retirement, however, an extra $1,000 per year “catch-up” contribution can be made once the account owner reaches age 55. Also, tax-deductible contributions, up to the annual maximum, can be made regardless of income and even in years with no income.
After age 65, HSA tax-free withdrawals can be used to pay monthly Medicare Part B and D premiums as well as Medicare Advantage plans.
“Using HSA money to pay for medical expenses and long-term care insurance in retirement is a great benefit for investors given the tax exemption on withdrawals made,” said Mike Hebner, financial adviser at McNally Financial Services Corp.
If you are eligible for HSA, it can be an additional and flexible tool for retirement or to use, as needed, while still employed. However, be sure to check with a professional financial adviser to see if this option meets your current and future medical expense needs.
Michael Bateman is retiree who previously worked in marketing and corporate communications.