The Most Overlooked Retirement Account
I work with hundreds of employees every year who are serious about retiring comfortably. They generally know the importance of contributing to their employer’s retirement plan and an IRA, which both have significant tax benefits. I’ve found that another of the best but most misunderstood retirement planning options is the health savings account (HSA), which has been around since 2003 in conjunction with the explosion of high deductible health plan (HDHP) options. Many employees think the HDHP is just a way for their employer to lower medical benefits costs, but for most employees, these plans offer so much more than that. Growing some retirement resources in an HSA can be beneficial for you in a number of ways:
Deferring money to an HSA is even easier to do than most retirement plans. You can have the funds taken directly from your paycheck, but you can also make direct deposits by check, by bank transfer and even in cash depending on where your HSA account is held. You also have until the tax filing deadline to contribute for the previous year.
They can be completely tax-free. HSA contributions are pre-tax and income and gains compound without tax dilution. For money you use to pay qualified medical expenses, there are no taxes ever.
There’s no use it or lose it. Not to be confused with a medical FSA, which often happens, HSA balances that aren’t used by year-end carry over indefinitely and can be invested as the HSA plan permits. Here’s what I’ve suggested to many employees: keep your HSA card at home and pay small co-pays (and perhaps the bigger ones) out-of-pocket. Let it go and let it grow! (You might want to keep the receipts though since you can still withdraw the amount you spent on qualified medical expenses from the HSA tax and penalty-free in the future.)
They can help reduce Medicare premiums. Most people don’t know that their Medicare Part B premiums are dependent on their taxable income from 2 years prior. If funds are taken from taxable accounts like an IRA or 401(k) to pay medical expenses, the resulting increased income can trigger premium surcharges referred to as IRMAA, doubling or even tripling your Medicare premiums. Using HSA balances for these expenses eliminates this additional taxable income.
They can supplement your retirement income.Generally, there’s a 20% tax penalty when you use money from an HSA for non-medical expenses. However, that penalty goes away when you turn 65 (and qualified medical expenses are still tax-free).
There are no required distributions. As with a Roth IRA, HSA balances aren’t subject to required minimum distributions and thus don’t create unnecessary taxable income. This allows you to continue deferring the tax and perhaps avoid it altogether with future medical expenses.
They’re available for both spouses. If you have extra HSA balances when you pass away, your surviving spouse can access the rest of it and enjoy the benefits. But don’t use your HSA as a wealth transfer tool. Once both spouses die, the beneficiaries get the remainder but must pay taxes on it regardless of how it is used after paying off the deceased’s final medical bills.
So how do you take advantage of an HSA? If you’re covered only by an HDHP, you can contribute up to $6,750/yr if you’re married ($7,750 if over 55) or $3,350 if you’re single ($4,350 if over 55). Don’t forget to factor in any money added to it as an incentive at work before making that extra deposit though. That needs to be subtracted to get to your maximum contribution limit for the year. If your workplace health plan allows you to stay on it after age 65 without filing for Medicare, you can put off Medicare filing until after your employment ends and stay eligible to add to your HSA to build additional tax-free funds to use later.
Our 2016 Generational Report reinforces the idea that small improvements in financial behavior can dramatically increase expected retirement balances and help you retire earlier. People generally think of saving for retirement in their employer’s retirement plan and an IRA. Taking advantage of an HSA’s benefits as well is another one of those improvements that can help you become financially healthier and write smaller tax checks!
By Paul Wannemacher, Contributor for Forbes Magazine