It can be a valuable (and tax-saving) retirement tool for some, but there are also a number of myths and misconceptions surrounding Health Savings Accounts (HSAs). One of the best primers on the subject—the plusses and the minuses–we’ve come across is a usnews.com piece by Ryan Guina, the founder of CashMoneyLife.com. His article:
“Most people know they should be saving for retirement in tax-preferred accounts, including 401(k)s and IRAs. This allows you to get a tax break while helping your money to grow faster for retirement. You also need to prepare for health care costs in retirement, and one powerful tool to help you do this is a health savings account.
“A health savings account is a tax-exempt trust or custodial account that can be set up to pay for future medical expenses. In order to be eligible to open a HSA, the individual (or trustee) must be covered by a high deductible health plan.
“High deductible health plans typically have lower monthly premiums and higher annual deductibles that traditional health plans. They are designed to insure against major expenses, but they don’t provide much coverage for routine medical expenses. For example, a trip to the doctor’s office for a cold or the flu will probably not be covered under a HDHP unless you have already met your annual deductible. This is where a health savings account comes into play. A HSA is used in conjunction with a HDHP to pay for smaller, routine medical expenses like a doctor’s visit.
“While not for everyone, a health savings account can offer tremendous tax benefits for retirees, and help you afford health care in your retirement years. Here are some of the benefits and drawbacks health savings accounts provide for retirement planning.
“Advantages of HSAs. These accounts can have a triple tax advantage if used correctly. A few of the tax benefits of health savings accounts include:
• Tax deductible contributions.
• Interest and earnings grow tax-free.
• Distributions are tax-free for qualifying medical expenses.
“It is important to note that HSA savings do not need to be used in the same year they are added. Participants can contribute to a HSA for decades and let their contributions build up over time. These funds can also be invested in stocks, bonds and other instruments.
“Drawbacks of HSAs. While there are plenty of benefits, not everyone is eligible to contribute to a HSA, and there are penalties if you want to use the money in the account for something other than medical costs. Some drawbacks of HSAs include:
• Funds from the account used for non-medical expenses (prior to retirement age) may trigger penalties.
• The annual contribution limit for a HSA is lower than an IRA.
• You can only contribute to a HSA until you reach Medicare eligibility.
• You must have a high deductible health plan to open a HSA.
“Withdrawals for non-medical expenses after age 65, or once you become eligible for Medicare, are not subject to a penalty. However, earnings and interest are subject to income taxes just like a traditional IRA.
“How to use a HSA for retirement savings. One of the biggest and most unpredictable costs of retirement is paying for health care. It is a fact of life that as you get older, your body starts to break down. This often leads to a big increase in medical expenses in your retirement years.
“A HSA can benefit retirees in several different ways. First, all medical expenses that you incur can be paid for with funds in the account. You won’t owe any taxes on withdrawals if the funds are used for health care costs. As long as the funds are used for medical expenses, the growth in the account is essentially tax free.
“If you are fortunate enough to remain relatively healthy during your working years and don’t incur a lot of medical expenses, you could build up a significant balance in your HSA. What you don’t use for medical expenses can be withdrawn during retirement (after age 65 or Medicare eligibility) with no penalty. But you will still need to pay income tax on the funds, just as you would with a traditional IRA distribution.
“While certainly a powerful tool for retirement planning, a HSA has one major drawback for retirees. In order to qualify for a HSA you must purchase an HDHP. Since these types of health plans have a higher annual deductible than traditional plans, you may have to pay more out-of-pocket medical expenses than you would with a traditional health care plan.
“You will need to be able to afford these higher deductible payments if you plan on using a HSA. And since a HSA is designed for these out-of-pocket medical expenses, you will need to decide whether to use HSA funds to pay these out-of-pocket expenses or cover the medical expenses from your savings and let your HSA balance continue to grow tax-free to use in your retirement years.
“Using a HSA for retirement is not for everyone. In order to take advantage of the tax breaks, you must either be very healthy or be able to afford to pay for out-of-pocket medical costs using another source of income. By sitting on your HSA funds, you are basically letting your savings grow tax-free over time. For healthy people who have minimal medical expenses, a HSA can be a welcome tax break.”
WHAT TO KNOW ABOUT A HEALTH SAVINGS ACCOUNT
