How to Strengthen Your Retirement Plan with an HSA Account

Written by Canty Financial - Published on November 3, 2020

In recent years a shift away from company sponsored Pension Plans has increased the emphasis of saving to 401K account. This trend makes 401K plan funding a vital piece of retirement planning.  When reviewing your retirement scenario, it is also wise to consider how funding an HSA account can provide an added layer of retirement security.  HSA's offer three tax advantages that make it an important way to bolster your retirement assets:

  1. Contributions reduce your taxable income
  2. Funds in the account grow tax-free
  3. Distributions may be withdrawn, tax-free, for qualified expenses.  

If you currently participate in a high deductible health insurance plan, you are allowed to set aside tax-deferred dollars in an HSA account.  Typical planning for how much to contribute each year revolves around how much you plan to spend in the year ahead. But as you approach retirement years, it is wise to maximize your contributions even if you don’t plan to spend it all in the coming year.  

Building your HSA Reserves

One of the best features of the HSA is its flexibility and portability, so unlike an FSA, the HSA is yours forever. Saving more than you may potentially use is a sound strategy because any funds that you contribute but do not use will roll over and grow tax free for as long as you keep your account.

Basic contribution rules

  • You must be a participant in a High-Deductible Health Plan
  • Rules allow for contributions up to the maximum regardless of your income. 
  • You may even contribute in years when you have no income, or if you are self-employed.  
  • At age 65, when you are eligible for Medicare, you will no longer be allowed to contribute. 
  • You cannot contribute if you can be claimed as a dependent on someone else's tax return.
  • Contribution deadline is April 15th - the same as your tax return
  • You may make contributions outside of employer payroll deduction.

2020 Contribution Maximums

  • Single filer: $3550. 
  • Families: $7100. 
  • Age 55 or older, may make a "catch-up" contribution of $1,000 per year 
  • A spouse who is 55 or older may do the same, provided each has his or her own HSA account
  • Your family's total annual contribution cannot exceed $9,100.
  • Contribution maximums are adjusted annually for inflation

Using the HSA funds

The funds in your account may be used for payment of out-of-pocket medical expenses in conjunction with your high deductible plan. When you withdraw the funds to pay qualified medical expenses, the withdrawals are tax free.  Some examples of HSA qualified withdrawals:

  • Office-visit co-payments
  • Health insurance deductibles
  • Dental expenses
  • Vision care (eye exams and eyeglasses)
  • Prescription drugs and insulin
  • Medicare premiums
  • A portion of the premiums for a tax-qualified long-term care insurance policy
  • Hearing aids
  • Hospital and physical therapy bills
  • Wheelchairs and walkers
  • X-rays
  • In-home nursing care, retirement community fees for lifetime care, long-term care services, nursing home fees
  • Meals and lodging that are needed when receiving medical care away from home
  • Modifications to make your home easier to live in as you age: ramps, grab bars and handrails.

Maximizing Your HSA Assets in retirement

“A healthy 65-year-old couple retiring in 2019 will need close to $390,000 to cover health-care expenses, including Medicare Parts B and D.  In addition, it is anticipated that Dental care will be of the biggest outlays for retirees, as original Medicare does not cover this expense.”

Potentially high medical expenses present an uncertain challenge for retirees. This challenge can be tempered somewhat by setting aside medical expense funds to use during retirement. An HSA account provides an alternative source to a traditional 401(k) or IRA. When funds are withdrawn from a 401k or an IRA, income tax will be due on the money, regardless of how the funds are being used.  In contrast, HSA funds withdrawn for qualified medical expenses are not taxed upon withdrawal. 

Until age 65, you should use the money exclusively for qualified medical expenses:  the distributions will not be taxable.   

Once you reach age 65, distributions for non-medical expenses are considered taxable income, however the withdrawal is not subject to a 20% penalty.  Using HSA assets for purposes other than qualified medical expenses is generally less harmful to your finances once you have 

reached retirement age because it is likely that you will be in a lower tax bracket if you’ve stopped working, reduced your hours, or changed jobs.

Another important difference from traditional retirement accounts is that there are no required distributions once you reach age 70½.  You keep the money invested until you need it.  

It is important when you open your HSA, that you designate a beneficiary for the account. Any funds that remain in the account will pass to your beneficiary upon your death. If you're married, your spouse can inherit the balance tax-free.  If the funds pass to someone other than your spouse, then the account balance will be subject to tax on the plan’s fair market value at time of inheritance. Consult your plan administrator if you are uncertain about, or want to make changes to your beneficiary designations. As with any investment account, it is important to revisit your designations from time to time as death, divorce or other life changes may alter your choices.

You’ve saved to your HSA account. Should you invest the funds?

“A small but growing number of consumers are investing their HSAs. As of mid-2017, HSAs held $6.8 billion in investment assets,, representing about 16 percent of all HSA assets, according to Devenir. The average investment account holder has a balance of $15,146, including both their deposit and investment accounts.”

By waiting as long as possible to spend your HSA assets, you will maximize your potential investment returns and give yourself as much money as possible to work with.  Investing some of the HSA funds can lead to tax-free growth of the assets, but you’ll want to consider market fluctuations and the timing of distributions the same way you would when taking distributions from an investment account.   The current inflation rate is 1.8%,  so the funds in cash may not keep pace with that rate. The bottom line is how much risk you can live with. You obviously want to avoid selling investments at a loss to pay medical expenses. If you think you can pay out-of-pocket medical expenses for the next 5-7 years, then you may consider apportioning your near-term needs vs. those that seem more than 5 years away.

You should be aware of potential investment/maintenance fees, and if the investment offerings are commission-free. 

Written By: Maureen Walsh

 --Maureen Walsh is an Investment Advisor and IRS Enrolled Agent at Canty Financial Management, Inc.,with offices in Ballston Spa, NY and Naples, FL.

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