The Long Term Power of the Health Savings Account
Health Savings Accounts (“HSAs”) are an underappreciated benefit offered to employees with high deductible insurance plans. The annual pre-tax contributions, which in 2017 are $3400 for individuals and $6750 for families, can be withdrawn tax-free at any time for medical expenses. Most people, however, fail to take advantage of the full benefit that these plans offer. Many still consider HSAs to be a health insurance add-on, and use it as a “cash in – cash out” account to pay for medical expenses as they arise. The popular impression is that it is a spending account, and not necessarily a means to accumulate tax deferred dollars year after year. This approach is completely missing maybe the biggest benefit of an HSA, the long-term power of the HSA.
What people often don’t realize is that any unused portion of an HSA account can be rolled over from year to year and investment growth can continue until assets are withdrawn. The investment options for HSAs are similar to that of a 401(k). A simple calculation of investing $6750 for ten years at a return of 7% will give you over $90,000. This would be an excellent way to tackle your single biggest expense in retirement, which is healthcare. Healthcare costs are difficult to estimate in retirement, but most advisors agree that even retirees with satisfactory Medicare coverage will still spend an average of $260,000 (per couple) on healthcare after the age of 65. About a third of the expense is for Medicare premiums, the rest going to co-payments, deductibles, drug prescriptions and other medical costs. A Kaiser Family Foundation report found that out-of-pocket expenses accelerate with age, with those 85 and older spending more than twice that of a younger beneficiary. And affluent retirees could find that their costs far exceed this estimate, due to the fact that their income requires them to pay more for Parts B and D coverage.
At age 65, you can take distributions from your HSA, for any reason, without penalty. If the distribution is for a qualified medical expense, it will not be taxed. Withdrawals made for other purposes will be subject to ordinary income taxes. Once 65, you can use your HSA to pay for Medicare parts A, B, C, D and Medicare HMO premiums, both penalty and tax free. You cannot use your HSA to pay for Medigap insurance premiums. Participation in any type of Medicare (A,B,C,D and Medigap) does make you ineligible to contribute to an HSA. If you delay Social Security and avoid being automatically enrolled in Medicare, and are otherwise HSA eligible, you can contribute to an HSA after age 65. However you can continue to use any accumulated funds for as long as you have funds in your HSA.
HSA accounts can be passed on to a spouse after death, retaining all the same rights as the original owner. HSAs inherited by non-spouses stop being HSAs. The account becomes taxable to the non-spouse beneficiary as ordinary income in the year the owner passes away.
If you are trying to determine where to save first and which savings vehicles should have priority, we recommend funding a 401(k) up to the corporate matching level first. No need to leave free money on the table. After that, consideration should be given to funding your HSA to the maximum allowable limit. HSA accounts are expected to remain available under future health care legislation.