Saving for retirement is a major undertaking for most of us. Increasing healthcare costs and longer life expectancies make the hill a bit steeper to climb each year. Health savings accounts (HSA) provide another vehicle to save for retirement.
Many of you have the option to enroll in high-deductible insurance plans that allow the use of a health savings account via your employer. An HSA can serve as an additional retirement savings vehicle on top of your IRA or 401(k) to help cover healthcare and other retirement expenses.
The rising cost of healthcare in retirement
According to Fidelity an average couple aged 65 will need to have $315,000 accumulated to cover medical costs in retirement. This is up from prior year’s estimates including $285,000 in 2019, $275,000 in 2017 and from $220,000 in 2014. The estimate was $190,000 in their 2005 survey.
This is a significant amount even for retirees with a retirement nest egg in excess of $1 million.
High deductible health insurance plans
Health insurance plans with an annual deductible of at least $1,4000 for a single person and $2,800 for a family qualify for use with HSAs in 2022, These limits increase to $1,500 and $3,000 for 2023. These types of plans are becoming more common with employers and are available privately as well. Premiums are generally less expensive than plans with lower deductibles. Out-of-pocket expenses for high deductible plans cannot exceed maximums of $7,050 for an individual and $14,100 for family coverage in 2022, increasing to $7,500 and $15,000 for 2023.
How the HSA works
HSA accounts can only be used in conjunction with a high-deductible health insurance plan. The HSA will be a separate medical savings account into which the employee or private policy holder can contribute money during the year. The money goes into the account on a pre-tax basis much like a traditional 401(k) or IRA. This is a great opportunity for those who earn too much to make pre-tax contributions to a traditional IRA. Those who have made the maximum contributions to their 401(k) have another pre-tax savings option available to them as well.
The HSA contribution limits for 2022 are $3,650 for individuals and $7,300 for families. These limits increase to $3,850 and $7,750 for 2023. Those who will be 55 or older at any point during the year are eligible to contribute an extra $1,000 in 2022, this remains unchanged in 2023. Some employers may also make contributions to employee’s accounts.
Money can be withdrawn tax-free from the HSA account to pay for a variety of qualified medical expenses. Withdrawals used to pay for non-qualified medical costs will be included in your gross income and included in your taxable income. Withdrawals for non-qualified expenses may also be subject to a penalty.
The real advantage is that money not used to cover eligible expenses can also be left in the account from year-to-year. This differs from a Flexible Spending Account (FSA) where all money must be used by the end of the year in conjunction with qualified medical expenses. Any unused dollars are lost to you.
The money in the HSA is portable when you leave an employer. Many banks and investment custodians offer HSA accounts, some with investment options that are similar to an IRA account. The investments chosen should reflect your risk tolerance and time horizon for the money. Just like an IRA account you should shop around for the HSA account that best meets your needs including investment options and fees.
Qualified medical expenses
Examples of qualified medical expenses include:
- Health insurance coinsurance and deductibles
- Most medical and dental expenses
- Vision care
- Prescription drugs and insulin
- Medicare premiums
- A portion of the premiums for a tax-qualified long-term care policy
These are just some examples of qualified medical and related expenses for which HSA funds can be used on a tax-free basis.
Health Savings Accounts and retirement
For those who can afford to cover some or all of their out-of-pocket medical costs from other sources while they are working, HSA contributions can serve as an excellent supplement to their other retirement savings in accounts like IRAs and 401(k)s.
Money in the HSA can be saved until retirement to cover qualified medical costs. This can make your retirement savings go farther. Remember the money comes out tax-free for qualified medical expenses.
Beyond medical expenses, once you reach age 65 the money can be withdrawn penalty-free for purposes other than paying for qualified medical expenses, though the withdrawals will be taxed as ordinary income rates like a traditional IRA account.
HSAs are not subject to required minimum distributions, allowing the HSA to continue to grow tax-free. If a spouse is named as the beneficiary of the account, he or she can inherit the money tax-free. Non-spousal beneficiaries will be taxed on the account’s fair market value.
The Bottom Line
With the cost of healthcare in retirement continuing to increase, the health savings account is increasingly being viewed as an additional retirement account. If you have access to one, consider funding an HSA account to help supplement your other retirement savings efforts.
Photo by Bill Oxford on Unsplash
Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.
NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.
FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.
Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.
HSA’s are a great way to get your annual taxable income down. It’s a situation where you KNOW you will spend this money at one point or another. So, why not take advantage of it? I know we’ve spent a small fortune on medical expenses related to our kids over the past several years. I only wish we would have maxed out our HSA from the get-go!
Thanks for your comment. The HSA is a great opportunity for those who have access to one.
What do you think would be the time to start a Healthcare Savings Account? I know the earlier the better, but there are so many investment opportunities that it’s difficult to determine what to choose to invest in. Thanks for this informative article.
Thanks for the comment. The earlier the better is true generally, but everyone’s situation is different. One feature of the HSA to keep in mind is that the money can be used to cover qualified medical expenses so if some of the money is needed for that purpose along the way the account holder still gets the tax benefits.
HSAs need to be enhanced in both services covered and contribution amount.
Specifically, HSAs need to be allowed to be used for Direct Care monthly/annual membership fees. The IRS has the authority to do so and they have the Congressional approval to do so via the PPACA. They have either not figured that out or have simply chosen not to.
As far as contribution limits, they need to be increased as the current amount is too low for most people to take good advantage of, especially as deductibles and out of pocket maximums continue to increase.
Thanks for your comment John. Good observations and I’d certainly support any enhancements that would increase the value of an HSA as a means to save for retirement expenses in general and healthcare costs specifically.
I think Fidelity’s number on the amount of money needed for medical expenses was low. EBRI just came out with their study. They suggest some couples may need $400,000 for medical expenses. While an HSA is good, a 401(h) Account is better. Most financial companies have a 401(h) for their retiree’s. However they don’t train their financial advisors to educate their small business clients on 401(h) accounts. It’s similar to an HSA, except the contribution amounts are much higher. A great deduction for small business owners as the 401(h) deduction is 9 times higher than an HSA.
Thanks for your comment and for the info Brett.