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Health Savings Accounts — One Key to a More Comfortable Retirement

Most people know that a 401(k) plan is a valuable retirement tool. It’s less well-known that a health savings account (HSA) also is a valuable retirement tool. Not only is an HSA a great way to save for medical expenses while employed, but the same savings account also can be used during retirement.

An HSA is a tax-advantaged savings account that employees can use to pay for out-of-pocket medical expenses. HSAs always are paired with qualified high-deductible health plans (HDHPs). Qualified HDHPs have low premiums but high deductibles and when HSAs are used for qualified medical expenses, HSAs have a triple tax free benefit: pre-tax contributions; tax-free growth; and tax-free withdrawals for qualified medical expenses.

If you offer an HDHP at your company, make sure your employees understand that HSAs also have some great retirement benefits. According to Fidelity Investments’ Retirement Health Care Cost survey, the cost of health care for the average couple throughout retirement is $280,000. Even with Medicare coverage, retirees should expect to pay for premiums, co-pays, some drugs and other expenses not covered by insurance. Money deposited in an HSA and saved for retirement can help cover these costs.

Here’s what your employees need to know:

Who Can Open an HSA? Any employee may open an HSA if they participate in a company HDHP and have no other health insurance; are not enrolled in Medicare; and cannot be claimed as a dependent on someone else’s tax return.

Benefits of an HSA. An employee’s account balance grows tax-free and any interest, dividends or capital gains earned are nontaxable, unless withdrawn for non-medical expenses. Also, any contributions you make to an employee’s account are not counted as part of their taxable income.

Unlike a flexible spending account (FSA), the balance can be carried over from year to year. Employees also take their HSA with them if they accept a position with another company or when they retire.

How HDHPs Work. In 2019, a qualified HDHP must have a deductible of at least $1,350 for self-only coverage and $2,700 for family coverage. Depending on the type of coverage offered, an employee’s annual out-of-pocket expenses in 2019 could run as high as $6,750 for individual coverage — or $13,500 for family coverage.

High health care expenses are one reason HSA plans are most popular with healthy individuals who can afford the risk and would receive benefits from the tax breaks. However, a low-deductible plan such as a PPO could cost individuals more than $2,000 annually in higher premiums regardless of whether they need medical attention. With an HDHP, spending more closely matches actual health care needs. In addition, HDHPs usually cover some preventive care services.

HSA Contributions. There are limits to how much individuals can contribute. For self coverage, the 2019 limit is $3,500 annually while the family coverage limit is $7,000. Account holders who are 55 or older at the end of the current tax year can contribute an additional $1,000 annually as a “catch-up contribution”. If you are married and both you and your spouse have separate HSA accounts, each of you are eligible for the $1,000 catch-up contribution. Contribution limits are adjusted annually for inflation.

Investing is Easy. Employees can contribute up to the maximum regardless of their income through payroll deduction or from their own funds until they reach age 65, even when they’re self employed or not working.

While the employer chooses the administrator, the decision of where to put the money is the employee’s. Encourage your employees to shop around for high-quality, low-cost investment options. Some providers only offer low interest-bearing investments, such as money market funds, that generally are very safe: while some HSAs offer multiple mutual funds that may provide higher expected returns over time but are more risky. In addition, some HSAs require a minimum contribution before investing the contributions into mutual funds within the HSA.

Here’s an example of how saving money in an HSA and getting a good rate of return can pay off. If a 21-year-old makes the maximum allowable contribution every year to a self-only plan until age 65 and they earn an average annual return of eight percent on a plan with no fees, they will have $1.2 million by the time they retire. For those who start saving later in life, a 40-year-old who saves $100 per month and earns an average annual return of three percent could have as much as $45,000 by retirement.

Qualified Expenses. Employees can take distributions from their HSAs before or during retirement. After retirement, HSA withdrawals get taxed in a way similar to Traditional IRA withdrawals, if retirees take distributions for non-medical expenses, but income tax-free if for medical expenses before retirement. If they take distributions on qualified medical expenses, the proceeds are not taxable. If they spend the money on anything else before they turn 65, they will pay a 20 percent penalty and also will pay income tax.

Qualified payments for which tax-free HSA withdrawals can be made include:

  • Doctor 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

When an employee retires, they also can use their HSA funds to pay for expenses that will help with their long-term needs, such as in-home nursing care, retirement community fees, long-term care services and nursing home fees. Withdrawals also can be taken for the cost of meals and lodging when seeking medical care away from home and modifications to a home, such as ramps, grab bars and handrails.

For more information about HSAs, please contact us.