One of the primary risks retirees face is the cost of health care. For retirees over age 65 (and a select few others on Social Security’s Disability program or suffering end stage renal disease) Medicare is their primary health care protection. Medicaid also helps with health care costs for very low-income retirees. Historically, health care costs for retirees have risen higher than inflation and with the aging of baby boomers are expected to continue the rise even faster.
An HSA, if used properly, is a vehicle that can provide some protection against rising retirement health care costs. Its unique features make it the only financial vehicle in the IRS code that saves you taxes when you contribute to it, and if used properly, saves taxes when you take distributions from it. In fact, some financial planners consider HSAs to be superior to 401ks and IRAs if used correctly.
What is a How Health Savings Accounts (HSAs)
An HSA is an employer provided tax-advantaged savings and investment vehicle. All employee contributions to the account are made pre-tax, thereby saving current federal and state income taxes on the contributions. Often, employers also make contributions to the account and these contributions are likewise free of current taxation. Furthermore, all contributions grow in the account free of tax. Typically, employers provide a savings account vehicle for the account to grow with interest until the balance reaches $1,000. Then, employees may invest the funds in an array of investment vehicles like those in a 401k.
An HSA works in conjunction with a high deductible health plan. For an employee to be eligible for an HSA, he/she must select the high deductible health plan option during open enrollment that works in tandem with the HSA. Once set up, the HSA is available to pay for or reimburse yourself for qualified medical expenses for you, your spouse, and all dependents you claim on your tax return. All distributions for qualified medical expenses are free of income taxation.
What is a High Deductible Health Plan (HDHP)?
A HDHP is a health plan with a higher than typical network health plan annua deductible. As a reminder, a deductible is the cost of health care expenses an employee is required to pay before the health plan coverage begins. With a HDHP there is a maximum out of pocket dollar amount that the employee is required to pay, including the plan’s deductible and co-pays. However, with a HDHP, the employee can receive preventive healthcare benefits without a deduction.
What are Considered Qualified Medical expenses?
As mentioned above, only qualified medical expenses (QMEs) are eligible for coverage under an HSA. These QMEs include: copays, deductibles, acupuncture, contact lens, OTC drugs, birth control, eye surgery, hearing aids, psychotherapy, family doctor, chiropractors, ambulance, eye glasses, dental care, home care, prescription drugs, transplants, and specialists.
What are NOT Considered Qualified Medical expenses?
Withdrawals for non-health related expenses are taxable and subject to a 20% penalty (with limited exceptions). Furthermore, withdrawals for insurance premiums are likewise taxable and subject to the 20% penalty with these notable exceptions: long-term care insurance, health care coverage while receiving COBRA coverage or unemployment benefits.
Also, if you are over 65, health insurance premiums are also exempt from tax and penalties, except for Medicare Supplemental insurance.
Who’s Eligible to Contribute to an HSA?
To be eligible to contribute to an HSA, an employee must meet all the following requirements:
-Must be enrolled in a HDHP on the first day of the month
-Must have no other health coverage other than vision or dental
-Must not be enrolled in Medicare or Medicaid
-Cannot be claimed as a Dependent on someone else’s tax return
Contributions to an HSAs
The maximum amount that an individual may contribute to an HSA in 2024 is $4,150. With Family coverage, the maximum contribution amount allowed for 2024 is $8,300. Some companies make contributions on the employee’s behalf. However, the maximum contributions amounts include both employer and employee contributions. Participants who are 55 years of age in 2024 may contribute an additional $1,000.
It’s important to recognize that participants can change the amount of their contributions at any time during the year. Also, participants may make contributions for the current year as late as April 15th of the following year, adhering to the same time-line rules as IRAs. Also, plans can accept rollover contributions that employees may have accumulated in HSAs with former employers.
The Power of HSAs
HSAs have unique tax characteristics. You may call them “triple tax free,” the only financial vehicle in the tax code that can make that claim. This is true because all contributions to HSAs are exempt from taxable income, saving both federal and state income taxes. The growth of the funds inside HSA accounts are likewise free of current federal and state taxation. Furthermore, withdrawals from HSAs to pay for qualified medical expenses are likewise not considered taxable distributions. However, withdrawals made for reasons other than qualified medical expenses are considered taxable and subject to a 20% tax penalty.
Once a participant reaches age 65, the 20% tax penalty for withdrawals for non-qualified medical expenses vanishes, and withdrawals for non-qualified medical expenses simply become taxable income, like most retirement plans. However, the real advantage of HSAs for retirees is that withdrawals for QMEs are considered tax free, thereby providing a way to pay for out-of-pocket health insurance premiums and retiree health expenses in a tax advantaged way.
Unlike Flexible Spending Accounts, HSAs don’t expire, and participants may carry over the balance from one year to the next. Furthermore, if a participant changes jobs, switches health insurance plans, or retires, they may take their HSA with them. Virtually all employers also accept tax free “HSA rollovers” from your past employers so you can transfer your existing HSAs to your current employer, thereby having all your HSA funds available in one place. For many employees, HSAs can be an important centerpiece for a wealth accumulation plan for a lifetime, including retirement.
What Happens to my HSA if I leave the Company?
The Funds in your HSA belong to you the employee. If you leave the company, most companies will allow you to leave your funds with the company, or you may roll them over to an HSA account with an investment firm. Generally, if you leave your company and leave your funds there, you will be responsible for additional fees as you no longer receive the preferential treatment that current employees do. If you go to work for another firm with an HSA health plan option, you may transfer your HSA funds directly to the new company’s plan without tax consequences.
Things to Consider Before Enrolling in a HDHP with an HSA
To use an HSA to maximum advantage you should have an Emergency Fund or sufficient income to Cover possible out of pocket health care costs that come with a HDHP. Without those resources available, you may have to borrow to cover your out-of-pocket health care costs thereby negating the advantage of an HSA. Furthermore, by using a ready cash savings account for current out of pocket medical expenses, you preserve the funds in your HSA to be used properly, for future retiree health care costs.
An HSA assumes you are motivated to save now in a tax advantaged way to pay for health care and other expenses in the future. If you’re not, an HDHP with an HSA is probably not a wise choice.
It’s also important to recognize the risks of a HDHP with an HSA (i.e., risk paying more out of pocket for health care costs currently) for the long-term benefits of building wealth and better meeting your retiree health care costs with an HSA.