Utilizing HSAs for Tax Free Retirement Benefits
Health Savings Accounts (HSAs) offer a unique opportunity for individuals and families to save pre-tax dollars specifically for future qualified medical expenses. In addition, the growth accumulates tax free provided the funds pay for qualified expenses. Health savings accounts offer you a powerful tool to help protect and build wealth and help to manage future healthcare costs. In this article, we’ll look at how to utilize HSAs for tax-free retirement benefits and the importance of timing your contributions, prior to retirement.
What is the ‘retirement’ benefit of an HSA?
HSAs are typically available through an employer, offered as part of a comprehensive benefits package and available to anyone with a high-deductible health insurance plan. Like IRAs, HSAs are individually owned. HSAs are one of the few medical savings vehicles allowing the investment of pre-tax dollars. Typically, HSA funds are invested into mutual funds selected by the employee or participant. When used for qualified medical expenses, the funds are not taxable. In addition, any interest or investment earnings accrued in the account are not taxed, potentially enhancing the growth of the accounts over time. This tax-free growth is especially beneficial when invested wisely, potentially facilitating substantial growth of the account balance over the years. As we grow older, the availability of such a tax-free health savings account may prove highly beneficial indeed.
HSA Contributions
There are rules limiting the annual maximum amount one can contribute to an HSA. For individuals, the maximum contribution limit is currently set at $4,150 per year, while for families, the limit is $8,300 per year. Like the catch-up contribution in an IRA, participants 55 years old or older can opt to invest an additional $1000 per year in an HSA. Periodically, contribution limits are adjusted for inflation, helping account holders keep up with rising healthcare costs. It’s important to note, combined contributions from both the account holder and the employer make up the maximum annual contribution amount.
Critical Changes Involving HSAs & Medicare
As individuals approach the age of 65, a critical change takes effect in the rules governing HSAs. This lesser-known rule involves persons approaching age 65 who plan to enroll in Medicare. Some individuals may need to stop contributions 6-months prior to enrolling in Medicare. The “6-month” lookback means if you receive Medicare benefits and continue to contribute to your HSA, you may face unexpected tax implications due to excess contributions. The current rules are not cut and dry. Enrollment in Medicare and stopping HSA contributions involves careful timing. In certain situations, you may not need to stop HSA contributions before your 65th birthday month. Navigating the nuances can be complex and we recommend consulting your HSA plan administrator or a tax accountant to interpret and advise on the current applicable IRS rules affecting your individual circumstances.
For an individual working beyond the age of 65 and not receiving Medicare benefits, ongoing contributions are permitted. When to enroll in Medicare is an individual decision and we recommend understanding the requirements of the “when and how” to avoid surprises. The time to end HSA contributions is an important consideration for individuals planning for retirement and looking to maximize funds in the health savings accounts. When contributions end, the funds accumulated in the account are available for qualified medical expenses and provide a valuable resource to cover healthcare costs – one that never expires.
What Happens to My HSA Funds If I Pass Away
Another benefit of an HSA is the ability to designate a beneficiary should you pass away with a balance in the account. What types of beneficiaries can inherit HSA funds? Like other beneficiary accounts, options for a beneficiary include a spouse, your children, your siblings, other relatives, or your estate. When a spouse is the beneficiary, both the inherited HSA funds and the spouse are bound by the same HSA rules and laws – including using the funds for qualified medical expenses. If the spouse also owns an HSA, they have the option to move the inherited HSA funds into their own individual HSA account. Due to tax complexities, we recommend consulting a tax advisor or tax accountant to understand your beneficiary options and any potential tax obligations.
HSAs vs. FSAs
A notable aspect of HSAs is, an HSA is not a “use-it-or-lose-it” account. Unlike Flexible Spending Accounts (FSAs), the balance in a Heath Savings Account accumulates, rolling over year after year. This potentially allows the account balance to grow over time, particularly when invested. The power of compounding may result in a substantial nest egg dedicated to healthcare expenses, providing potential peace of mind and greater financial security in later years.
Another key point about HSAs is the flexibility feature in terms of withdrawals. While the primary purpose of an HSA is to cover medical expenses, the funds are available for other purposes. However, if used for non-medical expenses before the age of 65, the withdrawal is currently subject to both income tax and a 20% penalty. After the age of 65, withdrawals for non-medical expenses are still subject to income tax, but penalties no longer apply. This feature gives HSA holders added flexibility to use the savings they have accumulated, though using those funds for healthcare expenses remains the most advantageous option.
Benefits of Investing Your HSA
To maximize the benefits of an HSA, it is crucial to fund it using pre-tax dollars and to invest the funds wisely. Investing HSA funds can potentially lead to significant growth over time, expanding an account into a powerful tool to help cover future medical expenses. The ability to invest HSA funds sets it apart from other healthcare savings options, as it allows for the potential of higher returns and greater financial security.
Funding an HSA offers several key benefits. Pre-tax dollars make up the contributions, providing an immediate advantage by lowering taxable income. The funds in the HSA grow tax-free and qualified withdrawals are tax-free, making it an efficient and beneficial way to save for future medical expenses. The current contribution limits allow for significant tax savings, especially when investing the funds to take advantage of compound growth. Although HSA contributions must stop once Medicare coverage begins (consult with the plan administrator or tax advisor to confirm), the funds accumulated in the account are available for healthcare-related costs, providing you valuable support during retirement.
For anyone eligible, an HSA represents a smart, tax-advantaged tool to prepare for future healthcare needs. By making regular contributions and investing wisely, account holders may potentially build a substantial balance dedicated to medical expenses and health care costs, helping to ensure more financial stability in the face of ever-rising healthcare costs. As medical expenses continue to climb, the importance of planning for health care costs is a fundamental consideration. An HSA offers a flexible, tax-efficient means of doing just that, making it an invaluable component of a comprehensive financial plan.
About the Author:
Troy Brewer has a talent for connecting successful people while serving as a respected mentor on the path to prosperity. By facilitating an all-encompassing approach to wealth management, Troy utilizes his extensive network of resources including estate planners, accountants, and business leaders to develop creative financial solutions for his clients. By fostering meaningful relationships, orchestrating financial strategies, and serving as a trusted confidant, Troy helps his clients achieve their desired life and legacy.
Troy has spent more than 25 years in the financial services industry, focusing on maintaining tight multigenerational relationships through a process-driven approach. As a Chartered Retirement Plans Specialist® and member of the Baltimore Estate Planning Council, Troy specializes in low-cost investments, complex / multigenerational wealth planning and tax efficiency. His clients include business owners, corporate executives, and affluent families. Learn more about Troy or schedule a consultation.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is reliable or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Troy Brewer and not necessarily those of Raymond James.
Please note, changes in tax laws or regulations may occur at any time and could substantially impact your situation. While we are familiar with the tax provisions of the issues presented herein, as financial advisors, we are not qualified to render advice on tax or legal matters. Raymond James does not provide tax or legal advice. Please consult your own legal or tax professional for more detailed information on tax issues and advice as they relate to your specific situation.
