Pandemic-related losses have business owners looking for ways to cut costs. High Deductible Health Plans (HDHPs) help employers provide healthcare options while minimizing expenses. Due to the higher deductibles and out-of-pocket costs, employers often pair a qualified HDHP with Health Savings Accounts (HSAs). In addition to helping employees meet healthcare expenses, HSAs can help them boost their retirement funds. How?
HSAs were designed to make healthcare more affordable through pre-tax contributions and more freedom in making healthcare choices. For those whose employers don’t offer an HSA, there are other institutions that offer them as well, like banks and credit unions. If an HSA comes from a source other than an employer, the related tax deductions for contributions are reflected on annual tax returns. Even if opened at work through a sponsoring employer, an HSA account belongs to the employee account owner and stays with them even if they leave the company.
HSAs have additional benefits in the form of triple tax advantages and investment opportunities. As more people look to future financial needs and plan for emergency expenses and retirement, HSAs can be an important part of savings and investment strategies for the long term.
Retirement Fund and HSA
Let’s review some HSA basics and how to build the account balance, then explore how to use an HSA account in retirement.
Tax Advantages for HSAs
HSAs help account owners cover healthcare deductibles and other qualified out-of-pocket expenses. Because HSAs offer multiple tax advantages, they can also supplement retirement savings
HSAs offer three different types of tax savings, called the “triple tax advantage”:
- Contributions are tax-free. Deposits made to HSA accounts through payroll deduction are taken out before payroll taxes are calculated, lowering total taxable income.
- Healthcare expenses are tax-free. HSA withdrawals are not taxed when used to pay qualified healthcare expenses.
- Account growth is tax-free. Interest earned on the balance in an HSA account and gains achieved on invested portions of the HSA balance are not taxed.
All taxes are deferred until the HSA account owner turns 65. At that point, any funds withdrawn for other than healthcare expenses is taxed as regular income, usually at a lower rate. Any distributions made for qualified healthcare expenses however remain tax-free, regardless of the account owner’s age.
HSAs do have annual contribution limits. Spouses, parents, or employers can also contribute to a person’s HSA, although the combined total of all contributions from any source cannot exceed the annual limit.
HSA Rollover
There is no “use it or lose it” provision at plan year end with HSA accounts. The balance can continue to grow tax-free until the participant withdraws it. All unspent funds in the account at the end of the year roll over automatically to the following year.
HSA Catch-Up Contributions
HSA account owners aged 55 and older can contribute up to $1,000 over the current annual limit to their accounts. This is called a “catch-up contribution,” intended to help older individuals build up their account balances as quickly as possible before retirement.
Investment of Your HSA Funds
HSA accounts pay minimal interest like a regular savings account. But did you know that most HSA accounts can also be invested, typically in mutual funds? Some HSA providers require a minimum account balance in order to begin investing, as low as $500 to $1,000. Once you have enough balance to meet the investment minimum, it’s easy to start growing your balance through investing. These invested funds may substantially increase your balance toward future medical expenses and retirement.
HSA Spending in Retirement
When you decide to retire, an HSA account provides more flexibility than an IRA or 401k retirement account. That’s because these other types of retirement accounts are taxed on all withdrawals. But after age 65, you can still use your HSA tax-free for qualified healthcare expenses. Some estimates put healthcare costs during retirement at $325,000 on average. So it is a smart financial strategy to build up your HSA balance as much as possible and using it for eligible expenses, rather than dipping into a 401k or IRA to cover out-of-pocket healthcare costs.
Some other retirement-related HSA benefits include:
- Bridging the gap to Medicare if you retire before age 65
- Paying for some Medicare expenses
- Covering part of a “tax-qualified” long-term care insurance policy
- Planning for the distribution of your estate (these rules are complicated, so you’ll want to consult an estate planning attorney)
After age 65, any HSA funds that are used for non-medical expenses get taxed at the account owner’s current tax rate without any extra penalty. If you’re under age 65, using HSA funds for a non-qualified expense will trigger a penalty in addition to the corresponding income tax.
Boosting retirement funds with an HSA is a smart, easy strategy to help provide for your “golden years.” HSAs offer a safe and tax-effective savings tool for retirement nest eggs. This is especially true for healthy people with minimal healthcare costs and those who invest the unused money wisely.
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