Fidelity conducted a study that estimates a 65 year old couple will need $300,000 earmarked to pay for healthcare expenses. This does not include costs for long-term care services. $300,000 of course represents true expenses, meaning the funds used to pay for those expenses will be net of taxes. If the bulk of your retirement savings are held in a traditional 401k or IRA, you will need close to $450,000-$500,000 in your account balance earmarked for healthcare costs alone. Therefore, many of my clients are leveraging the HSA as part of their overall retirement planning strategy, and I’ll summarize some of the benefits in more detail below.
1. You recognize a tax deduction today.
If you are single, the maximum contribution is $3,600 for 2021 ($3,650 for 2022).
If you are married and participating in a family plan for insurance, the maximum contribution is $7,200 for 2021 ($7,300 for 2022). If you are over 55, there is a $1,000 catch up contribution available as well. Unlike other tax efficient saving strategies, your adjusted gross income level does not phase you out of a contribution. Also, you don’t need to worry if you itemize your deductions or take the standard deduction come tax time, all contributions will reduce your taxable income. You will typically have the ability to make your HSA contribution before tax time. This is helpful as you could wait until March or April before making your contribution from the previous year after you estimate what your tax liability might be. Of course, consult with your tax advisor on federal and state tax impacts of making an HSA contribution.
2. Tax efficient growth
Once the contributions are made, the growth from year to year is not taxable. Unlike a taxable brokerage account (investing in stocks/bonds/mutual funds), you will not receive a 1099 for interest or capital gains purposes. Furthermore, the distributions are also tax free as long as they are used for qualified healthcare expenses. Unlike a normal retirement account, you don’t have to wait until 59 1/2 to take those qualified distributions. We will cover what a qualified healthcare expense is later, but think about the tax power of this vehicle. All other retirement vehicles that you take a tax deduction up front grows tax deferred, not tax free. Furthermore, tax free retirement vehicles like Roth IRAs, Roth 401ks, etc., don’t allow for a tax deduction up front! Therefore, the HSA has the best of both worlds from a tax standpoint in that it’s tax deductible, and grows tax free (as long as it’s used for qualified healthcare expenses).
A health savings account can be used for current medical expenses, or future medical expenses. This means you are not required to “empty out” your HSA at the end of the year, unlike it’s cousin, the Flexible Spending Account. This means that the HSA can be used in a year where you have abnormally high medical bills (major surgery, having a child, unexpected ER visit etc.), or can be used in future years, or better yet in your retirement years. Furthermore, there is no limit on the timing of reimbursement. Let’s say you had major surgery in 2021, but had some cash on hand to pay for the expenses. Therefore, instead of taking an HSA distribution, you decided to let it compound and invest it for the long term. Let’s say 15 years later, you needed to raise some cash. Well, let’s say that surgery set you back $5,000 out of pocket, you could reimburse yourself for that surgery that occurred more than a decade ago. This feature also allows you to grow the funds over time with compounding interest before reimbursing yourself. Make sure you have a process to archive receipts, which often times can be done with your HSA provider. The final component of flexibility is portability. If you leave an employer, the HSA always remains with you. You can even roll it over to a different HSA provider if your new company offers a plan that you want to participate in.
4. Growth opportunities
Given the ability to make contributions over your working years without the requirement of withdrawing funds, the HSA also offers an opportunity to accumulate a sizeable balance that can be used in your retirement years. Additionally, you can even invest those unused funds in a basket of securities such as mutual funds or ETFs for even more growth opportunities. Typically, the HSA provider will require some reserve amount that cannot be invested, let’s say $1,000. Once you exceed the $1,000 mark, you can choose from a menu of investment options that suit your time horizon and risk tolerance.
The tax deduction up front, the tax free growth, flexibility, and growth opportunity are all reasons why this vehicle is the most powerful vehicle you can utilize for retirement savings. We already know healthcare is going to be a major expense during retirement, so why not get the most bang for your buck when paying for those healthcare expenses and leverage the HSA?!