When determining how much money you’ll need per month for retirement, many advisors will tell you to plan on fewer expenses in some areas (transportation, clothing, and entertainment) and expect to spend more on other services, especially healthcare.
The Fidelity Retiree Health Care Cost Estimate states a 65-year-old retired couple in 2022 may need a whopping $315,000 to cover health care expenses throughout retirement. Of course, that amount will vary depending on when and where you retire, how healthy you are, how long you live, and if you’ll need long-term care.
But there’s a way for you to build up a healthcare fund now to use after you retire and supplement your Medicare coverage. It’s called a Health Savings Account (HSA) and may be the most beneficial tool in your retirement planning toolbox.
Key Takeaways
- Health Savings Accounts are tax-advantaged tools to help eligible participants save for medical expenses.
- HSAs are packed with benefits, not the least of which is the triple tax benefit: tax-deductible contributions, tax-deferred growth, and tax-free withdrawals for qualified expenses.
- You can continue drawing from your HSA through retirement, but there are some stipulations when transitioning to Medicare.
The Facts About HSAs
HSAs are relatively recent and were established in 2004 as a tax-advantaged medical savings account to encourage saving for future health care expenses. It took another eight years to gain popularity as more Americans chose high-deductible plans for their medical coverage.
HSA Eligibility
To be HSA-eligible—meaning you can open and contribute to an HSA—you need medical coverage under a High-Deductible Health Plan (HDHP) either through your employer or independently.
The monthly premiums for an HDHP are less than a traditional plan. To compensate, you’ll pay more out of pocket for health services before your insurance pays its share (your deductible). HSAs are available to help policyholders pay for that high deductible.
You are not eligible to contribute if enrolled in Medicare or claimed as a dependent on someone else’s tax return.
HSA-Qualified Medical Expenses
You can distribute HSA funds tax-free, but you must use the money for qualified medical expenses. What constitutes a “qualified expense” may differ between plans and providers, so you’ll want to ensure an expense is qualified before using your HSA (examples listed below).
If you want to use the funds on an unqualified expense, you may have to pay as much as a 20% penalty plus income tax on the distribution. But that penalty is waived once you’re enrolled in Medicare.
Before we get into more stipulations, let’s discuss the benefits of these accounts.
5 Incredible Benefits of HSAs
HSAs can be advantageous in your savings journey. Here are five considerable benefits using this account can bring to your financial life.
1. Triple Tax Benefits
Where many tax-advantaged accounts offer one or two benefits, the HSA ups the ante and offers three:
- HSA contributions are tax-deductible, meaning they reduce your taxable income in the year you contribute.
- You don’t pay taxes on capital gains, dividends, or interest as your money grows.
- Any withdrawals for eligible expenses remain tax-free.
An HSA is the only account that offers these robust tax incentives, so if you’re eligible to contribute, it could be a wise move. If you’d like to learn more about the tax treatments, check out IRS publications 962 and 502.
2. Your Employer May Match Contributions
Some employers offer a match to your HSA contribution. Remember, matches are free money you don’t want to leave on the table! While many employers require you to contribute before they match, some may offer a core contribution whether you fund the account or not.
Keep in mind that the annual contribution limit (discussed below) combines your and your employer’s contributions.
3. HSA Funds Can Roll Over Year-To-Year
The IRS sets a maximum contribution limit for HSA contributions every year. For 2022, the max is $3,650 for individuals, $7,300 for families, and contributors 55 and older are allowed an additional $1,000 to “catch up.”
Even though the annual maximums change, the funds themselves have no expiration date. Any money you don’t use throughout the year is yours to keep. Since the money rolls over each year, HSAs can be excellent long-term planning tools. If there are unused funds after your death, your surviving spouse can continue using the HSA in their name.
4. HSA Coverage Is Broader Than You Think.
At the start of the pandemic, Congress passed the CARES Act, which included expanded coverage for HSAs. You can now use HSAs to pay for certain over-the-counter medical products and medicines.
Once retired, you can use your HSA funds to pay for more than medical expenses, like housing and food. While you’ll avoid the 20% penalty, you must pay income tax for using the funds on non-medical expenses.
Say you also paid for medical services out of pocket before retiring. If you hold onto the receipts, you can reimburse yourself for those expenses through your HSA once you retire.
5. You Can Invest Your HSA Balance
Perhaps the best-kept secret of HSAs is that you can invest all of a portion of your funds in the account. Since the invested portion of your HSA doesn’t lose the taxation benefits at the federal level, you won’t need to pay tax on your earnings.
Consider this as an additional avenue to close the retirement healthcare gap—your carefully saved money can continue to grow even when you aren’t actively contributing.
At the Intersection of Medicare and an HSA
If you have an HSA, transitioning to Medicare is all about timing, and the magic number is usually 65. You can’t contribute to an HSA six months before enrolling in Medicare. But you can contribute up to that point, even if you don’t apply for Medicare until after you turn 65.
Your HSA is yours to distribute tax-free during retirement and use on prescriptions, Medicare premiums (parts B and D), doctor visits, glasses, dental work, hearing aids, and several other procedures and services you, your spouse, and other dependents may need.
Transitioning from your employer’s medical plan to Medicare can open questions and gray areas regarding your HSA.
- If my spouse is younger than 65, can they open and contribute to an HSA?
Yes. Your spouse’s age doesn’t determine HSA eligibility but whether they meet their employer or medical insurer’s eligibility requirements. Individuals don’t need to be the primary health plan subscriber to be HSA-eligible. You and your spouse can contribute to their HSA even if you are no longer HSA-eligible. This way, you can continue to build your medical fund years after you enroll in Medicare. - Whose medical expenses can I cover with my HSA?
You can reimburse your, your spouse’s, and any tax dependent’s expenses. Important exception: you cannot reimburse Medicare premiums for yourself or anyone else until you turn 65. - My spouse and I both have an HSA. Can we combine accounts?
No. You can deplete one account before using funds from the other to simplify the management. - Should I delay enrolling in Medicare to build up my HSA?
You can, but there may be penalties. With Medicare, late enrollment penalties are not one-time fees but are added to your monthly premium. You should discuss the advantages of delaying and any consequences with your financial advisor.
Start Contributing to Your HSA ASAP
An HSA is an incredible prep tool for retirement healthcare. The tax benefits are unmatched, and they’re a great way to mitigate and prepare for your medical expenses during retirement.
Unfortunately, Medicare won’t cover all your health care costs, with some estimating that you’ll use as much as 15% of your retirement fund for medical expenses. If you haven’t and you’re still eligible, consider opening an HSA and contribute as much as you can to take some of the financial load of healthcare off of your retirement funds.
As much as your income and health allow, try to pay for out-of-pocket expenses with other cash resources instead of using your HSA to build it up before you enroll in Medicare.
Contact us at Metanoia if you’d like to learn more about using and investing your HSA before and during retirement.
