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HSAs for Retirement

5 min read

30 sec brief

Right now your retirement planning is likely focused on how much you can save for that distant goal. Makes sense. But how much thought have you put into what you’re going to pay in taxes when you retire and start making withdrawals from your traditional 401(k), or individual retirement account (IRA)? Every dollar you pull…

Right now your retirement planning is likely focused on how much you can save for that distant goal. Makes sense. But how much thought have you put into what you’re going to pay in taxes when you retire and start making withdrawals from your traditional 401(k), or individual retirement account (IRA)?

Every dollar you pull out of traditional retirement accounts will be taxed as ordinary income. Moreover, that taxable income can impact the premium you will pay for Medicare coverage and can also increase the amount of your Social Security benefits that will be deemed taxable income.

A health savings account (HSA), if you start contributing to today, can leave you with a big chunk of money you can use tax-free in retirement, as long as the money goes to pay off qualified health care expenses.

Here’s how to use HSAs for retirement:

Sign up for a High Deductible Health Insurance Plan. To be eligible to save in an HSA you must be enrolled in a high deductible health plan. Chances are your employer offers an HDHP. If you buy your own insurance coverage, there are always HDHP options. In 2019, an individual policy with a deductible of at least $1,350 and a family plan with a deductible of at least $2,700 qualifies as an HDHP.

Contribute to an HSA. In 2019 individuals can contribute up to $3,500 to an HSA, and for family plan coverage the limit is  $7,000. If you are at least 55 years old you can contribute an additional $1,000 this year. Your contributions are tax-deductible.

In some instances, your employer may kick in a contribution to your HSA.

Aim to leave your HSA untouched until retirement. Money in your HSA can be used at any time, tax-free, to pay for qualified health care costs. But if you can handle your current deductibles and copays from your cash flow, you can then let your HSA account keep growing over the years. There is no “use it or lose it” provision with HSAs. That money is yours, forever, and there is no tax while the money is in your account.

Make the maximum contribution every year and you will likely be able to build a six-figure account you can tap in retirement without owing a penny of tax.

Save the medical bills you pay out of pocket today. Keep records of all the health-care-related expenses you are covering from your current cash flow. There’s a valuable quirk in how you can use your HSA in retirement if you have records of old health care expenses. (More on this in a sec.)

Invest your HSA. Most HSAs “default” participants into a safe bank account. That makes perfect sense if you are using an HSA to pay current medical bills. But if your goal is to have your HSA keep growing for retirement, you may want to consider investing the account in an appropriate mix of stocks and bonds based on your age and risk tolerance. Over decades, owning stocks will likely earn you returns much higher than the interest paid on safe bank accounts.

Use the money tax-free in retirement. As noted, you can use your HSA account to pay health bills at any time. This week, or 40 years from now. As long as the money is used to pay for a qualified health care expense, you will not owe any tax. That can be extremely valuable in retirement; when you are living on your savings and retirement benefits, minimizing your tax bill is extra important.

And keep in mind that Medicare typically covers around 70% of retiree medical expenses. Premiums, copays and uncovered services are on your dime. Over a 25 to 30 year retirement a 65-year old couple today might end up spending more than $250,000 on health care expenses.

Your HSA can also help you avoid big taxable withdrawals from traditional 401(k)s and IRAs that would likely knock you into a higher tax bracket.

Let’s say you are retired and you need to replace the roof on your home. The cost is $25,000 and you don’t have that much extra cash sitting in savings. If you want to tap your 401(k) or IRA you will likely need to withdraw more than $30,000 to end up with $25,000 after paying income tax on the withdrawal. Moreover, that $30,000+ will be counted as taxable income, so it could bump you into a higher tax bracket.

This is where saving all your old medical receipts comes into play. You can make a tax-free withdrawal from your HSA account to cover those old out-of-pocket costs at any time in the future. If you have documented evidence of $25,000 you spent in out-of-pocket costs over the years, you can make that $25,000 withdrawal from your HSA completely tax-free, and use it to replace the roof, or pay for anything you want.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

About the author

Carla Fried

Carla translates business and personal finance concepts into engaging content that helps individuals make more confident choices in how they manage their money. Her work appears in The New York Times, Money Magazine, Barron's and Consumer Reports.

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