There is a lot of uncertainty with healthcare lately, but two trends will likely continue: It will continue to get more expensive and you will continue to be responsible for more and more of the costs. Even with Medicare, it is estimated that the typical retiree will need between $200,000 and $400,000 to pay for health expenses during retirement. With that in mind you should seriously consider using a Health Savings Account (HSA) to help fund your retirement health expenses. You might be using one now, but if you’re like most, you’re not using it to its full potential. Let’s change that.
What is an HSA?
An HSA is a tax advantaged medical savings account available to people enrolled in high deductible health plans. Think of it as an IRA for your medical expenses. Unlike IRAs, however, HSA money is triple tax free: going in, as it grows and coming out. That is a huge advantage. The only caveat is that you need to spend the money on qualified health expenses or you’ll pay taxes and a penalty. The list of qualified expenses is rather long and even includes things like long-term care insurance premiums. Here are a few quick facts on HSAs:
- Contributions are tax deductible.
- The assets in the account grow tax free.
- Withdrawals for qualified medical expenses are tax free.
- If you take the money out for non-qualified expenses, you will pay taxes and a 20% penalty.
- Unlike FSAs, HSA dollars are not “use it or lose it.”
- Contributions can be made by either you or your employer.
- 2017 annual contribution limits are $3,400 for an individual and $6,750 for a family.
- Those over age 55 can make an additional $1,000 catch-up contribution each year.
- Money in the HSA can be invested in stocks, bonds and mutual funds.
A few things change at age 65…
- Distributions after age 65 are never subject to a penalty, even if not spent on qualified medical expenses. For non-qualified expenses just pay the taxes and use the money for whatever you want.
- At 65 you can pay for all Medicare premiums except Medigap with tax free HSA distributions.
- Once you enroll in Medicare, you can no longer make contributions to an HSA, but you can continue to use the existing money in your HSA.
Your best strategy
HSAs are growing in popularity, but they are not being used to their full potential. Because of the HSA triple tax advantage (in, out and during), the money should be invested for growth and allowed to compound as long as possible. Instead, here’s how most people use their HSA: 1) Add some money, 2) Leave the money in a no risk/no return money market, 3) Use the money as soon as they incur a medical expense.
Here’s how you should use your HSA: 1) Contribute the maximum amount allowed each year, 2) Invest the money in stocks, bonds and/or mutual funds, 3) If possible, pay for your current medical expenses out of pocket and allow your HSA money to grow until you retire. By doing that you are getting the most bang for your buck and creating a pot of money for retirement that can be used tax free for medical expenses or for anything else as long as you pay the tax.