By Joseph Stenken
Health Savings Accounts (HSAs) have been around for less than 20 years. They were created by Congress in 2003 to allow individuals and families who are covered by high-deductible health plans receive tax-preferred treatment of money saved for medical expenses. But HSAs can also be a powerful tool in your retirement. And some might say an HSA is a more powerful tool than an IRA or 401(k) plan.
An HSA is a tax-advantaged savings account that is designed to help individuals and families pay for medical expenses when they have a high-deductible health insurance plan. For 2020 a high-deductible health insurance plan is a plan that has a deductible of at least $1,400 for an individual and $2,800 for a family. In 2020 there is also a maximum out-of-pocket cost of $6,900 for individual coverage and $13,800 for family coverage. These out-of-pocket costs are one reason that many who are eligible to use an HSA decide not to. But there are studies indicating that paying higher premiums for a lower deductible plan may cost more money overall than paying the lower premiums of a high-deductible plan and paying for costs out-of-pocket.
In 2020 a person eligible to contribute to an HSA with individual insurance coverage can contribute up to $3,550 into an HSA and a person with family coverage may contribute $7,100. Those who will be 55 or older by the end of the year may contribute an additional $1,000. This is $1,000 total, not $1,000 per person covered under family coverage. Many employers contribute to an employee’s HSA as an inducement to choose a high-deductible plan. These employer contributions count against the overall contribution limits.
Contributions made to an HSA that are deducted from income and employer contributions are not included in income. HSA contributions also are not subject to the Social Security and Medicare payroll tax, unlike IRA and 401(k) contributions.
Distributions from an HSA that are used to pay qualified medical expenses are income-tax free. Qualified medical expenses are generally expenses that are allowed as an itemized deduction for medical expenses. Also, the CARES Act expanded the definition of qualified medical expenses to include menstrual products as well as over-the-counter medications even without a prescription. Distributions that are not used for medical expenses before age 65 from an HSA are taxable and subject to a 20% penalty tax unless the HSA owner is disabled or has died. Distributions from an HSA after reaching age 65 for non-medical expenses are subject to income tax, like distributions from a traditional IRA.
HSAs in Retirement
HSAs can be powerful tools when saving for retirement and for use during retirement. Like contributions to traditional IRAs, contributions to an HSA are tax deductible. HSAs can be invested in the same types of investments as IRAs such as mutual funds or brokerage accounts so HSAs can grow in the same way IRAs can.
In some ways using an HSA for retirement can have advantages over using an IRA in retirement. The biggest advantage is that distributions coming from an HSA to pay for qualified medical expenses are income-tax free. This is in contrast with money coming out of an IRA, which is taxable regardless of what expenses it is used to pay for. And even though qualified medical expenses do not generally include health insurance premiums, there is an exception for paying Medicare premiums or other health care coverage after the HSA owner reaches age 65. Medicare Part B premiums in 2020 for most individuals are $144.60 per month (which is 289.20 for a married couple). For those at higher income levels, Part B premiums can be as high as $491.60 (or $983.20 for a married couple). Using tax-free funds to pay these premiums can be a great advantage rather than paying them from funds that are taxable.
In addition, money from HSAs can be used to pay for long-term care insurance premiums at any time if the premium payments are less than certain limits.
And unlike traditional IRAs there are no required minimum distributions that need to be taken from an HSA. Meaning that someone doesn’t have to take money out when it is not needed. After the HSA owner reaches age 65, money can be taken out of the HSA for other reasons besides medical expenses and it will be taxed as ordinary income without penalty, in the same way money coming out of a traditional IRA is treated.
Because HSA accounts can use the same custodians as IRA accounts, HSA funds can be invested in the same investment accounts such as mutual funds or brokerage accounts. There are commentators who recommend individuals with HSA accounts treat those accounts the same way IRA investments are treated: do not use them until retirement to maximize the tax advantages. This would require paying medical expenses from after-tax funds before retirement. But if this is possible, it will result in a higher HSA value at a person’s retirement. It is important though that people with HSAs not put off health services to the detriment of their health solely for the purpose of growing their HSA.
One area where the rules for HSAs are less flexible than those for IRAs are for beneficiaries. Unless the beneficiary is a surviving spouse the entire value of the HSA becomes taxable to the beneficiary in the year of the HSA owner’s death. This is less flexible than the rules for an IRA beneficiary where most IRA beneficiaries now have 10 years to take money out of an IRA after the IRA owner’s death. But this rule is mitigated by the fact that funds from the HSA used to pay for the deceased HSA owner’s medical expenses within a year of death reduces the taxable amount of the HSA account. Like an IRA, a surviving spouse is treated as the HSA owner after the original HSA owner dies.
Health savings accounts, with their triple tax advantage, can provide individuals with an excellent way to save and invest for retirement. Someone who maximizes contributions, invests them wisely, and then leaves them untouched until retirement will provide additional flexibility in retirement.
About the author: Joseph Stenken
Joseph Stenken is an attorney who has been associated with the financial services industry for over 20 years. He has made presentations and written on a variety of topics including business planning, estate planning, and retirement planning. He is also a co-author of The National Underwriter Company’s The Tools and Techniques of Employee Benefit and Retirement Planning.