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Health Savings Accounts and Retirement Guide

More and more Americans are recognizing the full benefits of health savings accounts (HSAs) for their retirement planning, which has led to the rapid growth of HSAs in recent years. As both a solution to the rising cost of health care and a tax-advantaged way to save for retirement, HSAs are a particularly versatile type of benefit program. Understanding how to use HSAs for both immediate health care expenses and long-term retirement savings will help you get the most out of this benefit.

The numbers show that people are catching on to these dual benefits. According to the Employee Benefit Research Institute (EBRI), as of the end of 2016, there were an estimated 20 million HSAs with assets totaling $37 billion. From 2011 to 2016, the average annual contribution to these accounts rose by 24 percent, meaning that people in HSAs are making more use of them.

Should you join this growing wave of HSA participation? Find out how HSAs work, and how they can help you meet expenses both now and in retirement.

How does a health savings account work?

An HSA is designed to work in conjunction with a high deductible health plan. In fact, you are not eligible to participate in an HSA unless you also participate in a high deductible health plan.

Enroll in a high deductible health plan

High deductible health plans help keep health insurance premiums low by excluding from coverage a certain amount of routine expenses. For 2017, high deductible health plans are those with deductibles of at least $1,300 for individual coverage (or $2,600 for family coverage) and which cap out-of-pocket expenses at $6,550 for individuals and $13,100 for family coverage.

This means that in any given year, people in high deductible health plans may face between $1,300 and $6,550 in out-of-pocket expenses, or twice those amounts if they have family coverage. While having people shoulder a portion of their routine medical expenses helps keep insurance premiums relatively low, many people might have trouble finding available cash for these out-of-pocket expenses.

Maximum annual contributions to health savings accounts

That's where health savings accounts come in. HSAs allow you to make an annual tax-deductible contribution of up to $3,400 for an individual, or $6,750 if you have family coverage. This money can be invested without taxation, and is not taxed when you use it as long as you spend it on qualified medical expenses.

How can a health savings account help me now?

An HSA can help you build up a pool of tax-advantaged savings to help meet the out-of-pocket expenses that come with participating in a high deductible health plan. This is how most people use their HSAs. According to the EBRI, 63 percent of HSA participants withdrew funds from their accounts last year, and on average those participants withdrew over half their annual contribution.

The key is, when you compare insurance rates for high deductible health plans with premiums for plans offering more complete coverage, the high deductible plans should represent a substantial savings even after you consider out-of-pocket expenses paid for from your HSA. Participating in an HSA facilitates saving via a high deductible plan by giving you a tax-free way to save for those out-of-pocket expenses. Thus, you could save on medical expenses right from the start.

How can a health savings account help me save for retirement?

When people first start participating in an HSA, their focus tends to be on using it to meet year-to-year out-of-pocket expenses. Over time though, they often realize the benefit of also using the HSA to accumulate retirement assets.

Invest in tax-free savings

Money in an HSA does not have to be spent down each year. What you don't spend can be accumulated and invested to grow tax-free, allowing you to supplement your retirement savings.

In fact, unlike money in retirement accounts, the money you accumulate in an HSA is not even taxed when you take it out, as long as you use it for qualified medical expenses. Even if your health care expenses are relatively low now, you should find that you have no problem eventually finding qualified medical expenses you can use your HSA savings to cover.

According to the U.S. Bureau of Labor Statistics, for a person 65 or over, health care represents 12.9 percent of total expenditures, more than twice what it represents for someone aged from 35 to 44. In other words, some extra savings for health care expenses can come in very handy in retirement.

Should I save with a health savings account or a 401(k) plan?

Of course, you may already be saving for retirement in a 401(k) plan, so why bother with an HSA? There are two very strong reasons:

Advantages of health savings accounts

  • More flexibility with withdrawing money. Savings in an HSA can help you with health care expenses at any time, whereas you can't draw money out of a 401(k) before age 59 1/2 without facing a tax penalty.
  • Except from certain taxes. HSA deductions from your paycheck are exempt from Social Security and Medicare taxes. 401(k) contributions still count toward earnings for those types of taxes.

Advantages of 401(k) plans

  • Matching employer contributions. Naturally, some 401(k) plans have an advantage that most HSAs don't, which is an employer match on some contributions. So, one tactic to get the biggest bang for your buck out of your retirement savings is to invest enough in your 401(k) plan to maximize the employer match.
  • Lower fees. HSA fees may be a bit higher than 401(k) fees.

Above your max employer match, invest in an HSA until you reach the annual contribution limit. If you still have retirement money to set aside beyond that, you can allocate that excess into your 401(k) plan up to the annual 401(k) contribution limit.

While that sounds like it involves switching allocations back and forth, you can actually accomplish this in one move at your annual enrollment by calculating the contributions amounts that will both maximize 401(k) contributions and HSA savings. Then you would add any remaining savings you can afford to your 401(k) contributions and set up your payroll deductions accordingly.

If you take this approach, HSA fees could be more than 401(k) fees. You should be aware of fee differentials, but in many cases the extra tax advantage of an HSA will more than make up for them.

You should also be aware that if you take money out of an HSA for purposes other than health care expenditures, you are likely to face a 20 percent tax penalty, on top of ordinary income tax. However, given the rising cost of health care you should have no problem finding eligible health care expenses to spend the money on - both now and in the future.

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