Regardless of what comes out of Congress with regard to the Healthcare Bill, we know that healthcare costs will continue to be significant for retirees. One of the most efficient and valuable ways to help pay for these expenses is through health savings accounts (HSAs).

HSAs: An Overview

Health savings accounts are a type of savings account that allows people to set aside money on a pre-tax basis for the designed purpose of paying for qualified medical expenses. One of the most basic rules is that an individual must be enrolled in a high deductible health plan (HDHP) to contribute and cannot have other health insurance that is not a HDHP. Being enrolled in Medicare or being eligible to be claimed as a dependent on another person’s tax return also prohibits HSA contributions.

A HDHP, for purposes of HSA eligibility, is considered a health plan with a minimum annual deductible of $1,300 for a person under a single plan or $2,600 for a family health plan. Additionally, maximum out-of-pocket expenses must not exceed $6,550 for someone with self-only insurance and $13,100 for family health insurance.

Anyone on a self-only HDHP can contribute $3,400 annually to a HSA; whereas individuals covered under a family HDHP can contribute $6,750 annually for 2017. Each of these contribution limits allows for a catch-up contribution of an extra $1,000 annually for persons over the age of 55. Just like IRAs, individuals have until the April tax filing deadline of the following year to fund HSA contributions for the previous calendar year.

Triple Tax Savings (Potentially)

HSAs are one of the most favorable tax investment vehicles in existence today. Unlike IRA contributions, HSA contributions do not have an income limit which phases people out of making contributions. Thus, someone making $5M annually still has the ability to make an HSA contribution if they are covered under a HDHP and don’t run afoul of the other restrictions mentioned previously.

HSAs offer investors triple tax savings: any contributions are made pre-tax and can be deducted from income on the tax return, the earnings and growth accrue tax-deferred, and any distributions that are made for qualified medical expenses are tax-free. Examples of qualified medical expenses include most medical, dental, vision, and rehabilitative or chiropractic expenses. Tax-free distributions for medical expenses can be made at any time, even after a person retires and ceases making contributions.

Generally, if distributions are made for any other purpose besides a qualified medical expense, the distribution is subject to a 20% penalty. However, once people reach the age of 65, they can make distributions from an HSA for any purpose without penalty. At this point, the HSA essentially turns into a traditional IRA, and distributions for non-medical expenses are merely subject to income taxes.

Dispelling Myths About HSAs

If my employer doesn’t offer an HSA account I am not able to contribute to one.

False, as long as an individual or family is covered under a qualifying high-deductible health plan, they are eligible to contribute to an HSA. In fact, this includes people who have retired earlier and are covered under HDHP plans under the Affordable Care Act.

If I don’t use it, I lose it.

This is also untrue. Many people may be familiar with the similarly named Flexible Spending Accounts (FSAs) that disallow people from rolling over contributions from year to year. With an HSA, you will not have to worry about making a December 30th trip to the local Walgreens or CVS to use any remaining funds in the account. HSAs allow owners to build up unused balances and roll them over from year to year.

I am only able to pay for my own medical expenses.

False once again. In fact, individuals may pay for their spouse’s or dependent children’s medical expenses as well as their own. This even holds true if a spouse or dependent has his or her own medical insurance that is not HSA eligible.

I can only take a tax and penalty-free distribution in the year I incurred a qualified medical expense.

This is incorrect. Distributions can be made for qualifying medical expenses in a previous year, as long as a record that those expenses were paid out-of-pocket can be furnished and the expenses occurred after the HSA was established.

Medicare premiums can’t be paid for from an HSA.

This may be a surprise, but this is also false. Insurance premiums are not usually considered qualified medical expenses. However, when a person turns 65 and enrolls in Medicare, they can pay for all Medicare premiums (except for Medigap/Medicare Supplement Plans) from an HSA.

HSAs: Powerful Retirement Planning Vehicles

As I discussed in the opening, healthcare costs continue to rise and be one of the largest expenses for people in retirement. HSAs can be utilized in a way to help people mitigate some of these costs in retirement. The triple tax savings allow people to take deductions for contributions during their working (often higher income tax) years, have contributions grow tax-deferred, and afford tax-free distributions for medical expenses at any point later in life.

In order to use HSAs most efficiently, it might make sense to maximize HSA contributions each year while eligible under a HDHP and let these contributions grow like an IRA before using the funds for medical expenses in retirement. In many cases, people use HSA funds whenever they have a medical need, thus losing out on an opportunity for tax-deferred growth and potentially larger tax-free distributions in retirement. Another benefit of HSAs is that you can invest contributions in mutual funds and other vehicles, much like an IRA. A company like Health Savings Administrators offers HSAs with large investment lineups from money managers such as Vanguard, Dimensional Fund Advisors, TIAA Cref, and others. More and more, HSAs can be utilized like an IRA for their tax-deferral and growth capabilities with the objective of using the funds in retirement.

HSA Contributions and Medicare/Social Security

One disqualifying rule for being eligible to contribute to HSAs is being enrolled in Medicare. Keep in mind that a person must be enrolled in a HDHP to be eligible to make HSA contributions. Medicare is not a HDHP and thus excludes people from making HSA contributions while enrolled in Medicare. However, many people in today’s age choose to work past 65, when they would become Medicare eligible. It is perfectly allowable to opt out of Medicare and continue to receive healthcare coverage through an employer's high-deductible health plan, which would allow for additional HSA contributions.

Social Security retirement benefits can add another layer of complexity. When a person begins claiming Social Security at age 65 or later, they are automatically enrolled in Medicare Part A, meaning they lose the ability to continue contributing to an HSA. Thus, if someone wants to keep a window open to continue contributing to an HSA after 65, it makes sense to delay receiving Social Security benefits and maintain health insurance through their employer plan. When considering staying on an employer health plan after 65, please be mindful of Medicare Part B rules. If your employer has over 20 employees, this would allow you to delay enrollment in Medicare Part B (and A) and stay on the group health plan without penalty.

One-Time Qualified HSA Funding Distribution

Even though the tax treatment of HSAs (for non-medical expenses), pre-tax IRAs, and 401(k)s is similar once a person reaches age 65, they are two separate types of accounts that can’t be commingled. For example, a person with a $50,000 balance in an HSA account couldn’t roll it over to an IRA upon retiring at age 67. However, there is a one-time rule that allows an individual or family to roll a portion of an IRA over to an HSA account up to the annual limit ($3,350/$4,350 for self-only or $6,750/$7,750 for family coverage). This little-known exception is allowed only once per lifetime, and it could potentially save someone taxes on a distribution if they have exhausted HSA balances in retirement and have a qualified medical expense.

Conclusion

HSAs were designed to help people pay for qualified medical expenses. However, the favorable tax rules surrounding these accounts have allowed them to be used as a powerful retirement planning tool for people to combat large healthcare expenses in retirement. As with any tax recommendations, please consult your CPA or advisor to determine how HSAs fit within your overall portfolio. If you have any questions, please contact us.

IMPORTANT DISCLOSURE INFORMATION