Health Savings Accounts and Your Retirement
Health savings accounts (HSAs) come with three powerful tax benefits: (1) the dollars you contribute are deducted from your income, (2) investment earnings compound tax-free inside the HSA, and (3) withdrawals are also untaxed if the money is spent on qualified health-care expenses. (Depending on the state, HSA contributions and earnings may or may not be subject to state taxes.)
To be eligible to establish or contribute to an HSA in 2015, individuals must be enrolled in a high-deductible health plan (deductibles of at least $1,300 for individual coverage, $2,600 for family coverage).1 A deductible is the amount the insured must pay before insurance payments kick in.
HSA contributions are typically made through payroll deductions, but in most cases they can also be made directly to the HSA provider. Some employers make an annual contribution to employees’ HSAs. The maximum combined contribution limit is $3,350 for individuals or $6,650 for families in 2015. An additional $1,000 can be contributed starting in the year in which a participant turns 55.2
The primary purpose of an HSA is for workers to set aside pre-tax income to pay unreimbursed medical expenses. But an HSA could also play a role in your longer-term retirement strategy. For instance, research suggests that the average 65-year-old couple could spend as much as $220,000 on health-care costs in retirement.3 Any accumulated HSA funds could be used for these medical expenses.
A high-deductible medical plan, managed in combination with an HSA, may be a more affordable and flexible option than traditional health insurance. Many Americans are finding high-deductible plans in their workplace benefit offerings, and about 20% of the plans available on the new health exchanges are HSA-compliant.4
Premiums are typically lower for high-deductible plans than they are for traditional HMO and PPO plans. With an HSA-compliant plan, however, members usually pay more up-front for services such as physician visits, surgical treatments, and prescriptions, but they typically receive the insurer’s negotiated discounts. Annual physicals, health screenings, and some other types of preventive care are often provided at no cost .
Policies typically have out-of-pocket maximums, above which the insurer pays all costs. In 2015, the upper limit is $6,450 for individual coverage ($12,900 for family coverage), but plans may have lower caps. This feature can help policyholders budget accordingly for a “worst case” scenario.5
HSA assets are yours to keep, even if you change employers or retire. When unspent HSA balances reach a certain threshold (typically $2,000), funds can be steered into a paired investment account with more options.6
Although HSA funds cannot be used to pay regular health plan premiums, they can be used for Medicare premiums and long-term-care expenses. You can no longer contribute to an HSA after you sign up for Medicare, but account funds are still available to pay health expenses — or for any other purpose after you reach age 65. When HSA withdrawals are spent on anything other than qualified medical expenses, they are taxed as ordinary income (but don’t incur the 20% penalty that applies to taxpayers under age 65).
Younger and healthier workers who can afford to fund their HSAs generously could give some — if not all — of those dollars an opportunity to compound on a tax-deferred basis for many years. In fact, some people might prefer to pay current medical expenses out of pocket and preserve HSA assets to help meet future needs.