Fidelity estimates the average couple will spend almost $300,000 on medical costs once retired. This estimate doesn’t include OTC drugs, dental or Long-Term care (which is expensive). Funding a HSA can help you met this need (and Uncle Sam pays some of those expenses).
HSAs are the only triple tax savings vehicle I am aware of. Not only does it save on federal and (most) state income taxes, but Social Security taxes as well, if contributions are deducted from your paycheck. All growth and earnings in your HSA are tax-free. All withdrawals are tax-free if used for valid medical expenses. That is one reason, if you can afford to do so, you shouldn’t withdrawal from your HSA to pay medical expense until you really need the funds! The other reason not to touch the funds is any HSA withdrawal counts against your medical expenses you can claim as an itemized deduction! Since my company's retiree health plan is also a high-deductible health plan, or HDHP, I can keep contributing after I retire; the only difference is I need to send a check, as I cannot have it deducted from my pension.
HSAs are great, but you need to follow the rules
There are lots of rules around who can open one and how HSAs work. I will cover them to the best of my knowledge. The main purpose of having an HSA? Uncle Sam and your state are helping to pay for your medical costs!
HSAs are only available to someone enrolled in a High Deductible Health Plan (HDHP). You can also contribute to your HSA for your spouse if they are enrolled under the same HDHP. If your spouse has their own HDHP, they can set up their own HSA but then you cannot contribute on their behalf. In 2019, the individual contribution limit is $3500; plus, another $1000 if the owner is 55 or older. So, if your spouse is on your plan, you can contribute another $3500. If your spouse is 55 or older, you can save another $1000 for her but you must set up her own HSA for that contribution. If your company contributes to your HSA; that contribution counts towards the yearly maximum. The government doesn’t make it simple!
Once funded, you have two choices – use the money as you contribute or leave it in the HSA to use later. There are no time limits on usage as Flexible Spending Accounts have. My company gives us a card we can present to our doctors or pharmacy to pay what we owe. Or you can set up an online account and request funds to be either sent to your doctor or directly to you if you already paid what you owe. Documentation required to get funds from your HSA in either manner varies by the HSA provider.
Withdrawals have their own set of rules. While the level of documentation varies by provider, the main rules are the same. Qualified, non-taxable withdrawals must be for a medical expense you have documentation for – period! That could be your EOB from your medical insurance provider or Medicare documentation. All Medicare premiums you pay are also valid expenses, but not regular health care premiums. See IRS Tax code section 213(D) for current list of valid expenses. You can use the money in your HSA for non-medical expenses. If you do though, and are under 65, you'll be taxed on the amount you use and assessed a 20 percent penalty. Once you're 65, you'll be taxed for monies used for non-medical expenses but won't pay a penalty.
Medicare limits who can fund a HSA
Here’s the basic rule: Once the HDHP plan owner enrolls for any part of Medicare, you must stop contributing. The yearly contribution limit is then pro-rated for the year based on the month your Medicare starts (and that includes pro-ration of any employer contribution). If you keep your spouse on your HDHP and she enrolls into Medicare (remember, Part A is free), you can keep contributing for her to your plan but they have to stop any over-55 contributions to their own plan (again pro-rated). That is important to remember if you are already on Medicare and your employer starts offering a HDHP – you cannot enroll into a HSA!
You can invest your HSA contributions
While I currently have chosen not to invest my HSA balance (about $20,000), that should be an option with most accounts. Originally, not investing was due to my using the funds almost as fast as I was contributing (dumb idea!); which I am not doing now. My plan is to start investing some portion once I no longer can contribute (May 2020) and move the account to where most of my other accounts reside. Investing can make a difference if you are stating young, as shown in this graph I found on the Fidelity website.
Hypothetical scenario: Invested versus not invested (see assumptions below)
For illustrative purposes only. Assumptions: 30-year investment time frame; 7% return on investment; 0% return on cash; no withdrawals. The household contributes up to the HSA family limit each year at the beginning of the year. Contributions are indexed to inflation and compounded annually. Obviously, returns are not 7% every year.
The funds available within a HSA will vary by provider. These are the funds I have:
My employer gives me 4 equity index funds, 3 risk-level funds, and 2 fixed income index funds to pick from. There are no actively managed fund options. As with any investment you make in tax-free account, you need to decide how much risk you want to take as while gains are tax-free, you cannot claim losses on your taxes either nor add funds to make up those losses if you are already contributing the max. You also need to keep enough in cash to cover any withdrawals you want to make as you cannot withdrawal from any of the above directly – you need to sell them first, which raises the risk if yon need the cash during a market downturn. If you don’t plan on touching the HSA balance regularly, that risk would then be lower.
If your plan allows more options, including using any fund or individual stocks (Fidelity does), you can take more risk than what’s available above. Remember, don’t invest beyond your SWAN (sleep well at night) point!
- HSAs offer several benefits: not only spending for the short-term, but also saving for longer-term qualified medical expenses, including those in retirement.
- Because an HSA is one of the most tax-efficient savings options available, consider contributing the maximum and paying for current health care expenses from other sources of personal savings.
- If you can afford to pay for current medical expenses from your personal savings, consider investing a portion of your HSA assets in an asset mix that is somewhat less aggressive than your other retirement assets.
- Contributions and withdrawals contain penalties if not followed so be sure to ask if you are not clear on the rules at the time of your action.
- Remember to stop contributing once you enroll in any part of Medicare!
Note: For more detailed information, this Fidelity article can be useful.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.