Have you heard about Health Savings Accounts (HSAs)? If you are a high-end earner, you might assume an HSA isn’t ideal for you. But before you dismiss the idea, let’s cover why establishing one of these nifty little accounts during your career years might serve you very well in retirement. They pack more tax-planning punch than you might guess at a glance and HSAs can boost your retirement savings.

Still, you may hesitate. There are probably plenty of other expenses you’re already saving for – from your kid’s college, to homes and vacations, to retirement in general. Is it worth saving toward healthcare in retirement too? Won’t Medicare cover most of those costs?

Medicare in Retirement: Has It Really Got You Covered?

In fact, one of the biggest misperceptions we’ve seen among those saving for retirement is believing that Medicare means you’re all set once you hit 65. According to a HealthSavings.com publication, “The Ultimate Guide to Investing Your Health Savings Account,” the truth is:

  • Medicare typically only covers about 59% of your healthcare costs, leaving you to cover the remaining 41% from your retirement savings.
  • In the past 35 years, the inflation rate for medical care has been twice the inflation rate for all items. This 2017 analysis found that employer healthcare costs more than doubled from 2001–2015 (rising from 5.7% to 11.5% of employees’ pay), while overall benefit costs increased by a more modest 24%.
  • In its most recent Retirement Healthcare Costs Data report, HealthView Services found, “For a healthy 65-year-old couple retiring in 2021, total costs for premiums and out-of-pocket expenses will average $662,156.” Even if you’re healthy, costs could still trend that high, because insurance premiums are a significant slice of these expenses.

In other words, Medicare alone probably won’t cut it. Even a well-positioned family should set aside significant reserves for medical costs in retirement. Otherwise, dollars you’ve saved for realizing your actual retirement dreams might instead be eaten away by healthcare premiums, co-pays, and out-of-pocket expenses.

HSAs offer one way to prepare for the costs that Medicare won’t cover. If you can contribute to an HSA while you’re still working, your contributions are pre-tax (in an employer’s plan) or tax-deductible (in an individual plan). You can then let your HSA investments grow tax-free during your high-earning years. Eventually, you can withdraw the assets tax-free in retirement, as long as you use them to cover qualified healthcare costs.

In his 2016 paper, “Supplemental Saving In An HSA For Retiree Medical Expenses,” Buckingham Strategic Wealth’s Michael Kitces describes the opportunity as follows:

Given the inevitability of medical expenses in retirement, arguably the best savings account for retirement (or at least for a portion of retirement expenses) is to use a health savings account for retirement over “just” an IRA alone. … [A]ccumulating in an HSA [is] so desirable that it may even be preferable to pay current medical expenses out of pocket, just to preserve (and keep contributing to) the HSA account balance to be used as a future health retirement account!”

What is an HSA and What are the Benefits?

Basically, an HSA is a savings account you pair with a high-deductible insurance plan (whether employer-sponsored or individual). You fund your HSA to help pay for healthcare costs not covered by insurance. In exchange, the government offers you significant tax savings on that money. Not all employers offer a high-deductible plan/HSA combination. But if yours does, the intent is to help you and your employer lower insurance premiums, while boosting your ability to pay for the higher out-of-pocket costs.

Taking a closer look, HSAs include a few other features worth noting. They are:

Portable: Unlike a Flexible Savings Account (FSA), an HSA is yours, not your employer’s; it travels with you if you leave or retire.

Investable: You can decide how to invest your HSA assets to earn market returns over time.

Uniquely tax-advantaged: IRAs, 401(k)s, 529 plans, etc. all offer tax incentives, but only the HSA can be triple tax-free:

1.    HSA contributions are pre-tax on a paycheck, or tax-deductible if using after-tax assets. You also don’t pay FICA taxes on them, and many states also treat the contributions as tax-free.

2.    HSA investments grow tax-free.

3.    HSA withdrawals are also tax-free, as long as you use them on qualified medical expenses.

Tax treatment and contributions for HSAs and IRAs©Michael Kitces www.Kitces.com

Even if you spend the assets for non-medical purposes, as long as you wait until you’re 65 or older to do so, you’ll only pay regular income taxes on the withdrawals. That’ the same as if you were making the withdrawals out of a 401(k) fund. (There’s a 20% penalty if you take the money out for non-medical costs before you’re 65.)

Flexible: In contrast to an FSA, there are no “use it or lose it” rules on when you must spend the assets. You can roll them over indefinitely for spending in future years. If you save your healthcare receipts, you can even pair a past healthcare expense with a future HSA withdrawal years after you incurred the cost. Also of note: You can use HSA assets to pay for or reimburse yourself for eligible medical expenses incurred by you, your spouse, or your tax dependents.

Transferable between spouses: Unused HSA assets can roll over to a surviving spouse tax-free, with the same ongoing preferential tax treatment as if the assets were theirs to begin with.

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Advanced HSA Planning: Boost Your Retirement Savings with HSAs

What if bridging the Medicare gap isn’t a big deal to you? You’re already good to go on retirement healthcare costs. Even so, if an HSA is available to you in your career years, thanks to its flexible terms and unique tax structure, it can do more than cover current medical costs. With careful planning, it can become a powerful part of your overall, tax-wise wealth planning.

To illustrate, say you’re planning to use 401(k) funds to cover $400,000 in healthcare costs in retirement. After paying ordinary income taxes on the 401(k) withdrawals, your actual costs are probably going to be closer to $520,000.

If you instead pay these costs from an HSA, no additional Federal income taxes are incurred as you pay for them. You also paid no Federal income taxes on the assets up front, and many states also treat the assets as tax-free. So, paying medical expenses with HSA funds not only frees your 401(k) assets for other purposes, it gives you another tool for managing your overall tax burden.

In short, if you have excess cash-flow available today, an HSA may be an excellent, highly tax-efficient place to stash it.

To illustrate: 2021 HSA contribution limits are $3,600 for self-only and $7,200 for family coverage. Let’s say you contributed this annual maximum from age 30 to 65. Assuming a 6% rate of investment return, 25% tax rate, and 2% annual inflation, you’d have over $530,000 under self-only coverage and nearly $1.1 million under family coverage. Even if you started at age 50, you’d still have over $119,000 under self-only coverage or over $226,000 under family coverage.

In his report, Kitces notes:

“In other words, to the extent that medical expenses actually will be deductible anyway, the tax savings on medical expenses frees up additional dollars to contribute to the Roth IRA. In essence, it’s a double tax deduction opportunity – for the medical expenses now, and for the HSA to fund medical expenses in the future, and the HSA grows tax-free in the meantime.”

What Are “Qualified Medical Expenses”?

By now, you may be wondering what you can treat as a qualified medical expense. If the definition were too narrow, it would limit your ability to make good use of the account. Fortunately, there are quite a few items that qualify – and remember, the expenses can be incurred by you, your spouse, or your tax dependents.

As described by HealthSavings.com:

“Generally, an eligible expense is anything prescribed by a doctor for a medical condition that returns you to a normal state of health (like doctor bills, prescriptions, eyeglasses, or fillings). Certain insurance premiums are also eligible, like qualified long-term care premiums and COBRA. And although you’re not eligible for an HSA if you’re enrolled in Medicare, you can use existing HSA funds to pay for parts of you or your spouse’s Medicare premiums.”

You can find specific examples of qualified medical expenses at HealthSavings.com. Or, for a complete description, refer to IRS Publication 502, Medical and Dental Expenses, and IRS publication 969, HSAs and Other Tax-Favored Plans

How Cogent Strategic Wealth Can Help

As you might imagine, there are plenty of other details we could cover! If you have access to an HSA/high-deductible healthcare insurance combination, you are best served by consulting with a financial and tax-planning professional to determine if it would be a good, strategic fit for you and your family. If it is, there are also a host of strategical and procedural steps involved in making the most of the plan. Over time, you’ll want to:

  • Manage the HSA assets as part of your overall investment portfolio
  • Optimize your HSA’s tax-efficient use over the years
  • Incorporate the HSA within your retirement planning and total wealth strategies

For the last 10 years, Cogent Strategic Wealth has been helping busy, thriving professionals just like you make sense of HSAs, and the many other complex financial details that contribute to achieving your greatest lifetime goals. This includes helping you develop a comprehensive plan for accumulating the wealth you’ll need through systematic, evidence-based investing, while minimizing the financial risks you’ll face through appropriate risk management.

If you want to know more about how independent advice can help you realize your financial goals (while dodging some of the traps and hassles along the way), I hope you’ll sit down with our team today for a Cogent Conversation. We’ll listen to what success looks like for you, build a plan tailored to you, and help you execute that plan every step of the way. We will advise on how HSAs can boost your retirement savings to improve your overall plan too.

Don’t manage your financial future all on your own. Book your Cogent Conversation today!


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