As pandemic-related losses have driven business owners to cut costs, High Deductible Health Plans (HDHPs) have enabled them to provide healthcare options to employees while minimizing premium expenses. Due to higher deductibles, HDHPs require some adjustment on the part of employees. To help with out-of-pocket costs, HDHPs are often coupled with Health Savings Accounts (HSAs).
HSAs were designed to help make healthcare more affordable and give people more freedom in making healthcare choices. You can open an HSA through your employer and make pre-tax contributions. (If your employer doesn’t offer an HSA, there are also insurance, investment and banking institutions that offer them, with the tax deduction for contributions taken on your annual return.) Unlike some other employer-sponsored benefits, an HSA account belongs to the employee and goes with you if you leave the company.
HSAs offer triple tax advantages and investment opportunities. With the pandemic serving as a wake-up call to save more in case of emergency or potential early retirement, more people are looking at HSAs as part of a long-term saving and investment strategy. Before explaining how to use an HSA account in retirement, let’s start with some HSA basics and how you can build up your balance.
Tax Advantages Help HSA Money Grow
HSAs help account holders cover healthcare deductibles and other out-of-pocket expenses. Because HSAs offer several tax advantages, they can also supplement retirement accounts.
HSAs offer a triple-tax advantage in the following ways:
- Tax-free contributions. Deposits made to HSAs accounts through payroll deduction lowers the participant’s taxable income before payroll taxes are computed.
- Tax-free withdrawals. Withdrawals or transactions made for qualified medical expenses are not taxed.
- Tax-free account growth. Interest earned on the balance and gains from investing are not taxed.
It’s also worth mentioning that any unused money in an HSA account grows tax-free. If withdrawn after age 65 to pay a qualified medical expense, there is still no tax. If spent in any other way after age 65, the money is taxed at whatever tax rate the account owner qualifies for at the time (usually lower than when employed full-time).
Similar to retirement accounts, HSAs have annual maximum contribution limits. For 2023, they are $3,850 for individuals and $7,750 for families. If the account owner doesn’t contribute the maximum amount, anyone from spouses to parents to employers can also make contributions into the account up to a combined total of the annual maximum.
All unspent funds in an HSA account at the end of the year roll over to the following year. There is no “use it or lose it” provision, and the account balance can continue to grow tax-free until the participant withdraws it.
Another benefit of HSA accounts is the ‘catch-up’ contribution feature. Starting at age 55, HSA account owners can contribute up to $1,000 over the current annual limit to their accounts. For 2023, that raises the total annual contribution limits to $4,850 for individuals and $8,750 for families when the HSA account owner is at least 55 years old.
Investing Your HSA Funds
HSA accounts are like a basic savings account in that they pay minimal interest. But you can invest at least part of your HSA balance. Some HSA providers require a minimum account balance in order to begin investing, often as low as $500 or $1,000. Once you save enough to meet the investment minimum, you can more quickly grow your balance to use for future medical expenses and retirement.
Using Your HSA in Retirement
Once you retire, HSA accounts provide more flexibility than an IRA or 401k retirement account. These other types of retirement accounts are taxed on all withdrawals. However, after age 65, you can continue using your HSA for qualified healthcare expenses without any taxation on the withdrawal. Some estimates put average healthcare costs during retirement at $325,000. Setting aside funds in your HSA and using it tax-free for eligible expenses, rather than dipping into your 401k or IRA for those expenses, is a smart strategy.
Some other benefits relating to retirement that your HSA offers include:
- Bridging the gap to Medicare if you retire before 65
- Paying for some Medicare expenses
- Covering part of the premiums for a “tax-qualified” long-term care (LTC) insurance policy
- Planning in the distribution of your estate (consult an estate planning attorney, as these rules are complex)
After you reach age 65, any money withdrawn from the HSA account for non-medical expenses gets taxed at the participant’s current tax rate without penalty. However, if you’re under age 65, an HSA distribution for a non-qualified expense (healthcare or otherwise) will incur a penalty (currently 20%) on top of being taxed at the income tax rate for which you currently qualify.
HSAs offer a safe and tax-effective tool for creating a larger retirement nest egg, especially for healthy people with minimal healthcare costs and those who invest the unused funds wisely. No matter how you use it, your HSA and retirement go hand-in-hand.
DataPath Summit is a cloud-based administration platform offering comprehensive HSA management.