How HSAs Can Boost Your Retirement Savings
What makes an HSA so great?
The health savings account, or HSA, is an account intended to fund medical expenses that provides you with the best of all worlds from a tax standpoint. Similar to a traditional IRA, you are able to make tax-deductible contributions into the account. And similar to a Roth IRA, the growth and distributions from the account are tax-free, with one caveat: that you use the funds to pay for qualified medical expenses.
What makes an HSA even more attractive than any retirement account? Regardless of age, you can withdraw the funds tax-free and penalty-free if they are used to pay for medical expenses. For people looking to save more for retirement, an HSA can serve as a super tax-efficient vehicle for retirement healthcare expenses. (For related reading, see: HSA Strategies for Different Life Stages.)
According to the Employee Benefit Research Institute, a couple with median drug expenses would need to save at least $158,000 to have a 50% chance of setting aside enough money for retirement healthcare costs, and $271,000 for a 90% chance. If you were to make the maximum contribution to an HSA of $6,550 per year for a family, and use half of the contributions to pay for out-of-pocket medical expenses each year, the account would be worth about $45,000 in 10 years, $134,000 in 20 years, and $309,000 in 30 years, assuming a 7% return on investments.
Also, assuming a 25% tax bracket, these contributions would reduce your federal income tax by over $1,600 per year. Making maximum annual HSA contributions could be a very effective way to pre-fund a good portion of medical expenses during retirement. (For related reading, see: Using Your HSA as a Retirement Savings Tool.)
Can Anyone Contribute to an HSA?
Unfortunately, not everyone can make HSA contributions. In order to qualify for an HSA account, you must be enrolled in a high-deductible health plan, defined as plans with a minimum deductible of $1,250 per year for self-only coverage and $2,500 for self-and-family coverage. The maximum out-of-pocket limit is $6,350 for self-only coverage and $12,700 for self-and-family coverage. For 2014, the maximum contribution to an HSA is $3,300 for self-only coverage and $6,550 for family coverage. If you’re over the age of 50, you’re allowed an additional $1,000 catch-up contribution.
I’m Enrolled in Medicare. Can I Still Utilize an HSA?
Because Medicare is not a high-deductible health insurance plan, you are not allowed to make HSA contributions while covered by Medicare. However, you are allowed to make tax-free distributions as long as they are used to pay for qualified medical expenses. This is precisely why the HSA is an ideal savings vehicle for future healthcare expenses in retirement. (For related reading, see: Can Medicare Recipients Also Have an HSA?)
Can I Use an HSA to Invest?
Yes! Most HSA banks provide FDIC insured cash equivalent investments, which are currently earning next to nothing. However, there are custodians such as Health Savings Administrators, Health Equity and US Bank that offer mutual funds as investment options. So if your employer offers a high-deductible health plan, switching from your current plan and making HSA contributions is a no-brainer, right?
Not so fast. It’s important to look at the true cost savings of moving to a high-deductible plan. Because high-deductible plans increase the amount of potential out of pocket expenses, it’s important to look at how much you expect to utilize your health insurance coverage. High-deductible plans typically work best for relatively healthy people who aren’t utilizing health insurance benefits very often. If you’re in poor health or have children on your plan, make sure you look at the cost savings (premium reduction and tax savings) in conjunction with the projected increase in out-of-pocket expenses. HSA accounts are an “almost too good to be true” vehicle from a tax standpoint. However, it’s important to make sure it’s worth the increased deductible to justify having access to this vehicle. If you are in need of assistance in making this decision, consult a CFP professional.