Fund Your HSA to Cover Retirement Healthcare Costs

The following is courtesy of Marotta Asset Management.

Health Savings Accounts (HSAs) can provide inexpensive medical coverage if you maintain a healthy lifestyle. With your healthy lifestyle you may not spend anywhere near your high deductible insurance and consequently save on your medical costs. Even if you do not need to, we recommend funding your account with the maximum allowed. If your HSA builds up it may help you cover any extra medical expenses during retirement.

An HSA is a tax free savings account. As long as funds are spent on qualified medical expenses, all contributions, capital gains, and withdrawals remain untaxed. And like any other bank account, HSAs come complete with debit cards and checks.

But to qualify for one of these tax-free savings accounts, you must have a high deductible health plan (HDHP). Now, you may be thinking your insurance plan has a high enough deductible already. However, to qualify as a high deductible health plan, your insurance deductibles must be a minimum of $1,100 for individuals and $2,200 for families in 2007.

The good news is, once you meet your out-of-pocket deductible, most HSA-eligible high-deductible plans cover 100 percent of most medical expenses like emergency room visits, hospitalization, lab tests and prescriptions. Still, these deductibles are nothing to joke about. Paying a couple grand out of pocket before your insurance chips in may seem like financial suicide.

HSA-eligible high-deductible premiums are only a fraction of the cost of a traditional medical insurance plan. As an HSA owner you’ll likely do better than break even each year. With the savings on your insurance premiums, you should be able to accumulate a sizeable nest egg in your HSA.

Unlike your traditional health care plan, your HSA funds are not subject to a "use it or lose it" policy. Anything you don’t spend one year carries over to the next year. After all, it’s your money. While you’re on a roll, why not check out the invest options offered by your HSA bank?

Some people put only enough into their HSA each year to fund their medical expenses. This is shortsighted. We would recommend making the maximum HSA contribution each year, after covering your other financial needs.

In 2007, you can contribute $2,850 for individuals or $5,650 for families. If you are 55 or older you can make an extra $800 catch up contribution. In 2008, you can contribute $2,900 for individuals or $5,800 for families. If you are 55 or older you can make an extra $900 catch up contribution.

One you enroll in Medicare (typically at age 65) you can't make new contributions to your HSA. But any money left in your HSA will continue to accumulate tax free. It is a good idea to over fund your HAS while you are young so that during your retirement you will have some extra tax-sheltered dollars to use for medical expenses. After enrolling in Medicare, you can't contribute to an HSA.

Any HSA withdrawals that are not for qualified medical expenses are counted as taxable income and subject to a 10% tax penalty. The tax penalty does not apply, however, if you are 65 or older, or are permanently disabled. However, the withdrawals are still taxable at ordinary income rates.

In other words, any excess contributions you make to your HSA can be withdrawn after age 65 without penalty. Just like a traditional IRA, when the funds are used for non-qualifying medical expenses you will have to pay tax on the withdrawals, which is no different than other retirement savings option.

The law is currently silent on what happens to your HSA when you reach 70 1/2. We expect that the IRS will treat your HSA like an IRA and therefore require minimum distributions, but this has not been settled.

When you die, your surviving spouse inherits your HSA and it is treated as their HSA if they are named as the beneficiary. Otherwise, your HSA ceases to be an HSA and is included in the federal gross income of your estate or the named beneficiary.

There are three strategies that you can use to grow your HSA large enough to cover your retirement years. First, make the maximum allowable deposit to your HSA each year. Second, if your medical plan includes the option, invest your HSA in mutual funds instead of keeping your account entirely in an FDIC-insured savings account. And third, delay reimbursing yourself from your HSA account as long as possible to profit from its tax sheltered compounding interest.

You can reimburse yourself for qualified medical expenses at any time, but you also have the option of leaving the money in your HSA so that it continues to grow tax free. You can save all your receipts in a shoe box for decades and then decide to withdrawal your reimbursements at any future date when you need the money. This allows the growth on these funds to continue to compound tax-free.

Once you turn 65 and enroll in Medicare you can no longer fund your HSA. Medicare will pay for the majority of your health expenses during retirement. There are some expenses, however, that Medicare will not cover that your HSA can. In retirement, your HSA can cover proactive health screenings, unconventional treatments for terminal illnesses and nursing home expenses. Your HSA can even cover long term care expenses if you decide to self insure, or pay your long-term care insurance if you decide not to. None of these expenses will be paid by Medicare.

Another option during retirement is to enroll in a Medicate Medical Savings Account. This account is similar to an HSA, but funded in retirement by Medicare contributions. If you select a Medicare MSA during retirement, you can use the funds in your HSA until you build sufficient value in your Medicare MSA.

Maximizing your contributions to an HSA may secure your health care spending for life. Even if you end up not needing it, you can pay income tax and withdraw it without penalty after age 65 just like a traditional IRA.

Comments

[Robert]

Are there any well known places that specialize in or offer HSAs? I've just now started hearing about these accounts and know little about them. I think it's pretty important because while "they" always talk about needing less money in retirement, the medical bills will almost certainly be substantially higher and a lot of people probably don't factor that it.

My husband and I both have HSAs. I've made regular monthly contributions this year, but will skip December in order to avoid contributing more than the annual limit for 2007. The paragraph below says, "it's a good idea to OVER fund..." I believe that is incorrect. I think they meant to write, "it's a good idea to FULLY fund." I imagine that OVER funding would require filling out a lot of tax forms to explain my bad behavior, something I want to avoid!

"One you enroll in Medicare (typically at age 65) you can't make new contributions to your HSA. But any money left in your HSA will continue to accumulate tax free. It is a good idea to over fund your HAS while you are young so that during your retirement you will have some extra tax-sheltered dollars to use for medical expenses."

A second apparent error in the article is below. "Any excess contributions..." Since you aren't allowed to MAKE excess contributions, I feel certain the article writer has used the wrong word here.

"In other words, any excess contributions you make to your HSA can be withdrawn after age 65 without penalty."

Finally, the paragraph below says "if your medical plan includes the option..." My medical plan is Humana. They could care less whether I've set up the HSA portion of my plan, and whether or not that HSA allows me to invest in mutual funds. The bank where I've set up the HSA may or may not allow my HSA money to be invested in mutual funds. But Humana--my medical plan--has nothing to do with it.

"Second, if your medical plan includes the option, invest your HSA in mutual funds instead of keeping your account entirely in an FDIC-insured savings account."

FMF, please correct me if you think I've misunderstood what the article writer has said. But if I'm right, I think these are important distinctions!! Thanks.

[Katy Raymond]

FMF, the above comment is from me, Katy Raymond.

[Amanda]

I'm so glad you posted this. The company I work for has just introduced the option of HSA/High Deductible Insurance instead of our standard FSA/standard insurance plan. Deductible for single person (me) would be $2000, however, the company is offering to put $1500 (over 12 months) into our HSA. In this way I would never have to spend more than $500, plus the monthly cost will be reduced by over 30%.

From reading this post, I get the feeling this would be a good deal. If I contribute the maximum ($2850-1500=$1350) each year, I would be guaranteed to save $850 for retirement health expenses, more if I don't need to utilize my full deductible. Does that sound right?

[Cigar Jack]

I've been using this at work for the past two years. Currently I only fund it up to my deductible of $4500 for the family and I even convinced a few coworkers to switch to it. They were scared of the High Deductible and didn't bother researching it enough thinking an HSA was like a FSA and they'd lose it at the end of the year. One of the guys thanked me and bought me lunch when he realized how much money it saved him in the long run.

[John]

I've had an HSA ever since 1997, the first year they were available (and known at the time as Medical Savings Accounts). In talking with others, I too find that the high deductible scares people. That's a shame, because it shows how conditioned people have become to thinking low deductibles equals better health coverage.

There's no magic bullet to health care in the US. But HSAs make sense for literally millions of Americans. And there are more options than there were in 1997 -- so shop around and see which HSA plan is best for you (especially if you're self-employed).

[Lord]

Just don't confuse this with the other medical accounts you can have that expire annually losing any money you don't spend.

[Robert]

So, are HSAs pretty much the domain of the employer, like a 401(k), or can you set up your own?

[Matt]

I setup an HSA after I got out of college because I did not have a full time job after I graduated. It was actually a really cool feeling knowing that if anything happened, I would only be out the amount of my out of pocket maximum ($2500 I think). That's a lot better than my plan at work, where the maximum for a family is $7500. I hated to give it up, but had to so my wife could get coverage.

Weird. I almost agree with one of these Marotta copy-n-paste blog entries. Usually they are skewed towards those in the upper incomes, but today they are only skewed to the healthy and wealthy. :)

HSAs are absolutely great if you can afford them. But the high deductible health plan can be big trouble if you get sick (think diabetes) or have a child with a congenital illness. They are usually a good deal if you are young and healthy. Check out the fine print very carefully. Some don't negotiate with your doctor for the best price (ask your doctor for the cash price before you sign up for these - it can be many times the insurance price).

[Bethany]

Can a person open an HSA if it's not offered through their employer? Where do you find them?

[Kevin]

Bethany - you have to have high deductible health insurance to open an HSA and get the benefits. Most large insurance companies now offer high deductible health plans. I would assume most large banks now offer the bank account that goes along with it. My bank (US Bank) does and it's pretty good size here in the Midwest.

Watch out though, like another commenter said HDHPs are not for everyone and some have very limited coverage. I had one while I was single and it worked great - I got the benefit of the "network" prices the insurance company negotiated. But I am pretty healthy and didn't have any major expenses. Mine didn't cover maternity though, so when I got married I found a traditional health plan that did.

[kitty]

I have high deductible/HSA as one option, but I don't choose it. Why? I have another free-for-employee option - a PPO and flexible spending account.
I am relatively healthy, but I do have some medical expenses. With HSA/high deductible, most of the regular visits would be out of pocket as I'd never spend enough to cover the deductible. Sure, it'll go out of HSA, but it is still my money. With a PPO, I pay 20% of regular office visits (negotiated prices), 0% for preventive visits and my deductible is one third of what I'd have in high deductible/HSA plan. At this time, it just doesn't make sense for me.

Also, I can pretty much predict most of my yearly expenses with FSA.

"With your healthy lifestyle you may not spend anywhere near your high deductible insurance and consequently save on your medical costs."
It is pretty naive to think that a healthy lifestyle has this tremendous impact on future health. Healthy lifestyle reduces risks of certain conditions, but it doesn't eliminate risk entirely. A lot of people do everything right and still get sick. Some people don't do anything right and stay healthy. Many things are genetic, many are just bad luck.

[ginny]

Our broker suggested a few plans and we are leaning towards the Blue Shield of California Spectrum 5000 PPO for about $168/mo (covers us both, includes maternity, $5000 individual deductible). Another option is Blue Shield Spectrum Savings 4800 for $270/mo (4800 joint deductible, with an option to get and HSA). Thoughts? Can you really save money using an HSA? Why would I want to pay more money for an HSA option when I could just invest my own money freely and make sure I'm covered in retirement with an IRA and other investments, etc.?

[Ron]

I have the same thought as the comment about investing the money in another investment before retirement. Aside from the matching dollars that many employers provide, I am not sure why it would be better to invest in an HSA where the funds are only avaialble for health care, versus putting the maximum allowed in a 40qk per year? The max annual allowed for a 401k is likley far more than most people come close to. So until a person reaches the max allowed in a 401k, why would they invest in a more limited (health care only) plan?

[Mike]

Hope some of the previous commentators have since learned of their errors. I'm self employed and have had an HSA for several years. The Pluses:

It allows me to put pre-tax dollars into savings; meaning ALL medical expenses paid from it are tax deductible.

If I don't use, in one year, the amount deposited, it rolls over into the next year and doesn't impact that year's allowed amount.

Once I accumulate over $5500, I can invest it and only pay taxes on the earnings. Better than an IRA, since the money went into the HSA pre-tax.

Young, healthy people could amass an incredible amount of savings and subsequent investments.

Accumulations, withdrawn in later years, when the person is earning less, will be at a lower tax rate-another advantage over IRA's , where deposits are made during higher earning years.

The benefits far outweigh the negative of high deductible insurance requirements.

Just wish I could have access to a Medical Savings Account (with Medicare) in my locale when I turn 65.