Capitalize On Compound Interest By Investing Hsa Funds
Healthcare is a consistent cost we need to think about. But even if you see your medical bills rising in the future, you dont need to panic. You may just have to find ways to bulk up your savings. One way to do that is by developing an investment strategy early on. Examine the funds you intend to put away into your HSA. Instead of contributing all of the money, consider putting some aside for investing purposes. By dedicating a portion of your cash for possible tax-free growth, you can give your retirement better financial footing.
There are a few ways to invest those funds, though. Your methods should depend on the type of investor you are and your risk tolerance. A higher risk tolerance may call for a more aggressive strategy, whereas lower risk requires caution.
You Can’t Contribute To An Account But You Still Can Use The Money
My wife and I turn 65 this year and will sign up for Medicare. Will we still be able to use the money in our health savings account?
You sure can. Even though you can’t contribute to an HSA after you sign up for Medicare, you can keep the account and use the money tax-free for medical expenses. In fact, you can use the money in the HSA for anything after age 65, although you will owe taxes on any withdrawals you make for nonmedical expenses.
There are plenty of medical expenses to which you can apply the money. For example, you can tap the account for Medicare deductibles and co-payments. You may also be able to use HSA money to cover premiums for Medicare parts A, B and D , and to pay Medicare Advantage plan premiums. You may also use HSA money to help pay qualified long-term-care premiums. However, you can’t use HSA money tax-free to pay medigap premiums.
What Is A Qualifying Medical Expense For An Hsa
The IRS defines qualifying medical expenses as “the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body.”
The IRS doesn’t consider a medical expense to be “qualifying” just because it may generally benefit your health. For example, the IRS specifically states that vacation costs are non-qualifying expenses, even if getting away may be beneficial to your mental or physical health. Qualifying expenses must be “primarily to alleviate or prevent a physical or mental disability or illness.”
The IRS provides a long list of qualifying expenses in Publication 502 to help you determine if you can use your HSA funds to pay for a particular product or service. You can use your HSA funds to pay qualifying expenses for both yourself and eligible dependents.
You can generally use HSA funds to pay for medical services offered by practitioners, along with diagnostic devices, supplies, and equipment care providers need to offer their services. Some of the most common HSA-eligible expenses are:
- Prescription medications
- Eye care, including contact lenses and glasses
- Infertility treatments
- Veterinary care
- Weight loss programs, unless part of treatment for specific diseases
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Hsas Vs Other Retirement Savings Options
How do HSAs compare to other savings vehicles? The tax treatment of HSAs provides the potential for greater investment growth and greater after-tax balance accumulation versus other retirement or health care savings options. Assuming you use HSA funds to pay for qualified medical expenses, you do not pay any federal taxes. That’s why it’s at the top of the list for tax-efficient investment options for your retirement. In this hypothetical example, a customer invests $1,000 in their HSA.
Over the next 30 years, that single investment of $1,000 grows at 7% a year to $7,612. If that HSA account holder invested the same $1,000 in a tax-deferred account like a traditional IRA, their total investment return would also be $7,612. However, of that amount, only $5,938 remains after paying income taxes at an effective rate of 22% upon distribution.
Tax-deferred growth versus HSAs
Designate Hsa Funds For Healthcare Costs
You probably know what its like to save money for a financial goal. Maybe you opened a 529 savings account for a childs college expenses. Or perhaps you stockpiled paychecks to purchase a new car. Based on the goal you had, or still hold and its time horizon, you adjusted your savings style.
Healthcare can be expensive, especially the older you get. Potential hospital bills, medical procedures, prescription medication and nursing home costs could hit at any time or sooner than you think. Thats why its important to stockpile funds for a nest egg now.
According to Fidelitys Retiree Health Care Cost Estimate, a typical retired 65-year-old couple in 2021 may need around $300,000 for retirement healthcare costs. With that in mind, saving assets to cover healthcare is a vital step in retirement planning. Because of that, youll want to ensure you put away enough funds in your HSA specifically for medical care.
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Let Your Funds Grow And Use An Hsa For Qualified Health Care Expenses
With some planning and if you dont need the funds to pay for expenses while youre working, you can start to think differently about your HSA. The real power in an HSA is its compounding and growth, says Sri Reddy, senior vice president of retirement and income solutions at Principal®.
Lets say you open an HSA when youre 40 and save the maximum per year, including the catch-up contribution starting when you turn 55. Youre also able to treat your HSA like a true retirement vehicle and pay for medical expenses with other funds in your budget.
More Key Facts Affecting Medicare And Hsa Coordination
It’s simplest to lay out the facts followed by an example to best help taxpayers and their advisers apply the nuances to specific situations:
Example 1: To illustrate how the six-month lookback period operates, let’s say that A plans to work until age 67 in order to reach her full Social Security retirement age and opts to defer Medicare until then as well in order to continue funding her HSA. If A’s birthday is July 1 or later that year, she simply needs to stop any contributions to an HSA during the calendar year of retirement six months prior to her birthday.
Example 2: Using the above example, except for changing A’s retirement date to April 1, 2021, her Medicare enrollment with the six-month lookback would actually be Oct. 1, 2020. If A fully funded her HSA by the maximum allowable amount for 2020, she would need to recalculate for the two months of ineligibility then take steps to remove the excess contributions from the account. If A had already filed her 2020 income tax return before removing the excess contributions, an amendment may be in order as well to account for the loss of the tax deduction taken for ineligible contributions.
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Benefits Of An Hsa After Age 65
The short answer: it can save you money in the long run.
If you use your HSA like a traditional retirement account to pay for living expenses, travel and the like, you will pay income taxes on the earnings portion of your distribution. Conversely, you will pay income taxes on your entire distribution from your 401k or IRA. If you have a Roth IRA, you wont pay taxes on the distributions since you already paid income taxes on the contributions.
However, if you use your HSA money to pay for qualified medical expenses, you wont pay any income taxes on the distributions regardless of whether or not they include earnings. This matters because the average 65-year old couple who retired in 2019 could expect to spend $285,000 or more on healthcare in retirement . If you were to use your HSA contributions and earnings to pay for these expenses, you would need to withdraw $285,000 from your account. But if you fall into the 12% tax bracket , you would need to withdraw $319,200 from your IRA or 401k to pay for the same expenses. Thats a savings of $34,200!
Another great benefit of an HSA is that you get to decide how much you want to take out and when. Conversely, the IRS requires you to start taking whats called a required minimum distribution from tax-advantaged retirement accounts starting at age 72.
Let Hsas Play A Role In Your Estate Plan
In the event that your medical expenses are much lower than average , you may have money in your HSA that you can pass along to your heirs. The rules are complicated so it’s best to consult your estate planning attorney. There are generally 3 categories to consider when determining how HSA assets are treated upon your death:
1. Spouse is the designated beneficiaryIf your spouse is the designated beneficiary of your HSA, it will be treated as your spouse’s HSA after your death with the same triple-tax-free treatment.
2. Spouse is not the designated beneficiaryIf your spouse isn’t the designated beneficiary of your HSA, the account stops being an HSA, and the fair market value of the HSA becomes taxable to the beneficiary in the year in which you die.
3. Your estate is the beneficiaryThe fair market value of the HSA is included on your final income tax return.
Of the 3 options listed, many people would prefer to name the surviving spouse as the designated beneficiary. However, if you don’t have a surviving spouse, a planning consideration could be tax-efficiency. In that case, consider naming as beneficiary , whichever party is in the lowest tax bracket. Work with your tax and estate planning professionals to determine which option is right for you.
Tip: One caveat: If you name your estate as the beneficiary of your HSA, it will likely become a probate asset and it still needs to fit in with your overall estate plan.
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Benefits Of Using An Hsa For Retirement
There is a variety of tools that can help you save for retirement. While many of us know about 401s and IRAs, not as many may be familiar with health savings accounts . These are savings accounts designed for people with high-deductible health plans. Funds from an HSA account can cover qualified medical expenses and come with the additional perk of tax advantages. Because of this and other benefits retirees may benefit from owning an account. Here are ways you can make your HSA work for you in retirement.
For help with HSAs and other retirement planning accounts and strategies, consider working with a financial advisor.
Who Can Get An Hsa
Before you can put money into an HSA, you need to figure out if youre even eligible for one. HSAs are only available to individuals and families with a high-deductible health plan .
In 2022, thats a plan with a minimum annual deductible of $1,400 for individuals and $2,800 for families.3 It also has to have a maximum annual out-of-pocket expense of $7,050 for individuals and $14,100 for families.4 5 If you meet those qualifications, youre in!
If youre enrolled in Medicare or someone else can claim you as a dependent, no dice. The federal government says youre not eligible for an HSA.
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What Is A Health Savings Account
HSAs are tax-advantaged savings accounts designed to help people who have high-deductible health plans pay for out-of-pocket medical expenses. While these accounts have been available since 2004, many eligible Americans are not taking advantage of them.
These types of high-deductible health plans are offered by about 22% of employers who offer health benefits as of 2021. According to a March 2019 report from the Employee Benefit Research Institute , anywhere from 21.8 million to 36.8 million people had HSA-eligible health insurance plans in 2018, but only 11%-22% of those individuals had actually opened an account.
Moreover, people with HSAs had an average balance of just $3,221 in 2019. In addition, only 7% of HSAs were in investment accounts other than cash, as of 2019. EBRI found that virtually no one contributes the maximum, and nearly everyone takes current distributions to pay for medical expenses.
A true pittance, considering that the allowable annual contribution in 2021 is $3,600 for those with individual health plans and $7,200 for those with family coverage .
All of this means that consumers who have HSAsas well as consumers who are eligible for HSAs but havent opened oneare missing out on an incredible option for funding their later years. Its time to start a new trend.
If You Want To Understand More About Hsa In Retirement And Medicare Here Are Answers To Some Of The Most Frequently Asked Questions:
- Premiums for Medicare Parts B, D and Medicare Part C
- Medicare deductibles, co-pays and co-insurance
- Dental and vision expenses
- Long-term care insurance premiums
- Over-the-counter medical equipment and supplies
- Over-the-counter medicine
- Increase your payroll deduction.
- Make a contribution to your account on the member website.
- Mail a contribution form with a check.
- You are not yet enrolled in Medicare.
- Youre covered on a high-deductible health plan.
- Youre not someones tax dependent.
- Has elected an HSA-qualified health plan for the current coverage year.
- Is not covered by another health plan.
- Does not receive any military health care benefits.
- May not be claimed as a tax dependent on another persons tax return.
- Is not enrolled in Medicare.
- Speak with your financial advisor.
Tools & Support
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Don’t Spend Your Contributions
This may sound counterintuitive, but we’re looking at an HSA primarily as an investment tool. Granted, the basic idea behind an HSA is to give people with a high-deductible health plan a tax break to make their out-of-pocket medical expenses more manageable.
But that triple tax advantage means that the best way to use an HSA is to treat it as an investment tool that will improve your financial picture in retirement. And the best way to do that is to never spend your HSA contributions during your working years and pay cash out of pocket for your medical bills.
In other words, think of your HSA contributions the same way you think of your contributions to any other retirement account: untouchable until you retire. Remember, the IRS does not require you to take distributions from your HSA in any year, before or during retirement.
If you absolutely must spend some of your contributions before retirement, be sure to spend them on qualified medical expenses. These distributions are not taxable. If you are forced to spend the money on anything else before youre 65, you will pay a 20% penalty and you will also pay income tax on those funds.
How Much Can I Contribute To A Hsa
The IRS sets limits that determine the combined amount that you, your employer, and any other person can contribute to your HSA each year. For 2021, the maximum contribution amounts are $3,600 for individual coverage and $7,200 for family coverage . You can add up to $1,000 more as a “catch-up” contribution if you are age 55 or older.
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Invest Your Hsa Funds And Watch The Earnings Compound
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2 Medpac, July 2020 Data Book: Health Care Spending and the Medicare Program
Principal® does not make available products related to Health Savings Accounts.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment or tax advice. You should consult with appropriate counsel, financial professionals or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.
The Retirement Wellness Planner information and Retirement Wellness Score are limited only to the inputs and other financial assumptions and is not intended to be a financial plan or investment advice from any company of the Principal Financial Group® or plan sponsor. This calculator only provides education which may be helpful in making personal financial decisions. Responsibility for those decisions is assumed by the participant, not the plan sponsor and not by any member of Principal®. Individual results will vary. Participants should regularly review their savings progress and post-retirement needs.
Key For Hsas Save Your Medical Receipts
As you can see from the examples above, you need to be organized when using an HSA in retirement.
You need to keep all records of medical expenses paid for out of pocket, so that you can reimburse yourself in retirement. Whether you use a shoebox fill of receipts, keep a careful digital record, or let your financial advisor help you, be sure you are staying on top of this!
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