Hidden Gem: HSAs in Retirement
When saving for retirement, you're probably
aware of the benefits of using tax-preferred
accounts such as 401(k)s and IRAs. But you
may not be aware of another type of
tax-preferred account that may prove very
useful, not only during your working years but also in retirement: the health savings account
HSA in a nutshell
An HSA is a tax-advantaged account that's
paired with a high-deductible health plan
(HDHP). You can't establish or contribute to an
HSA unless you are enrolled in an HDHP. An HDHP provides "catastrophic" health coverage that pays benefits only after you've satisfied a high annual deductible. However, you can use funds from your HSA to
pay for health expenses not covered by the
Contributions to an HSA are generally either tax
deductible if you contribute them directly, or
excluded from income if made by your
employer. HSAs typically offer several savings and investment options. Your employer will likely indicate which funds or investment options are available if you get your HSA through work. All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost.
Withdrawals from the HSA for
qualified medical expenses are free of federal income tax.
However, money you take out of your HSA for
nonqualified expenses is
subject to ordinary income taxes plus a 20%
penalty, unless an exception applies.
Benefits of an HSA
An HSA can be a powerful savings tool. First, it
may be the only type of account that allows for
federal income tax-deductible or pre-tax
contributions coupled with tax-free withdrawals.
Depending upon the state, HSA contributions
and earnings could be subject to
state taxes. In addition, because there's no
"use it or lose it" provision, funds roll over from
year to year. And the account is yours, so you
can keep it even if you change employers or
lose your job.
HSA as a retirement tool
During your working years, if your health
expenses are relatively low, you may be able to
build up a significant balance in your HSA over
time. You can even let your money grow until
retirement, when your health expenses are
likely to be greater.
In retirement, medical costs may prove to be
one of your biggest expenses. Although you can't contribute to an HSA once you enroll in Medicare (it's not considered an HDHP), an HSA can
help you pay for qualified medical expenses, allowing you to preserve your retirement accounts for other expenses (e.g., housing, food, entertainment, etc.). And an HSA may
provide other benefits as well.
- An HSA can be used to pay for unreimbursed
medical costs on a tax-free basis, including
Medicare premiums (although not Medigap
premiums) and long-term care insurance
premiums, up to certain limits.
- You can repay yourself from your HSA for
qualified medical expenses you incurred in prior
years, as long as the expense was incurred
after you established your HSA, you weren't
reimbursed from another source, and you didn't
claim the medical expense as an itemized
- And once you reach age 65, withdrawals for nonqualified expenses won't be subject to the 20% penalty.
However, the withdrawal will be taxed as
ordinary income, similar to a distribution from a
401(k) or traditional IRA.
- At your death, if your surviving spouse is the designated beneficiary of your HSA, it will be treated as your spouse's HSA.
HSAs aren't for everyone. If you have relatively
high health expenses, especially within the first
year or two of opening your account, you could deplete
your HSA or even face a shortfall. In any case, be sure to review the features of your health insurance policy carefully. The cost and availability of an individual health insurance policy can depend on factors such as age, health, and the type and amount of insurance.