Over the past few years, the health savings account (HSA) has increasingly been referred to as an exceptional retirement savings option. But what exactly are HSAs, who is eligible to open them, and what makes them so great?
What Are HSAs?
An HSA is a tax-advantaged account that can be used to pay for specific qualified medical expenses. Unlike flexible spending account (FSA) funds, which are designed to cover current out-of-pocket medical costs, HSA funds never expire and can be used to pay for health care expenses before and during retirement.
Generally, contributions to an HSA are tax deductible, the earnings accumulate tax deferred, and withdrawals are tax free as long as they’re used to pay for qualifiedexpenses. Qualified medical expenses include lab fees, prescription drugs, and dental and vision care, as well as the cost of out-of-pocket health insurance deductibles.
You may also use withdrawals from your HSAs to pay for certain insurance coverage, including:
- Long-term care insurance (subject to specific limits and guidelines)
- COBRA health care continuation coverage
- Health care coverage while receiving unemployment compensation under federal or state law
- Medicare and other health care coverage if you are 65 or older, excluding premiums for a Medicare supplemental policy such as Medigap
If you withdraw funds from an HSA and do not use the money for qualified medical expenses, the withdrawal will be subject to a 20-percent penalty, in addition to income tax. After age 65, however, distributions not used for qualified medical expenses aren’t subject to the 20-percent penalty.
In 2018, the HSA contribution limits are $6,850 for a family account and $3,450 for an individual account. If you are 55 or older you may make an additional catch-up contribution of $1,000 per tax year. Contributions to an HSA can be made for the current tax year any time prior to the tax-filing deadline of April 15.
What Are the Benefits of HSAs?
In addition to their triple-tax-advantaged status, one of the biggest benefits of HSAs is that there is no time frame during which the funds have to be used. As mentioned previously, money in FSAs must be used to cover current out-of-pocket medical costs, and funds not used in one year may expire. HSA funds, on the other hand, never expire, so they can be used to pay for health care expenses now and during retirement. As such, many financial practitioners recommend that you use current cash flow (or FSA funds) to pay for out-of-pocket expenses while maximizing contributions to an HSA and letting the funds grow tax free.
According to a 2017 study by Fidelity, a 65-year-old couple retiring in 2017 would need $275,000 to cover health care expenses throughout their retirement—a 6-percent increase over the 2016 estimate and a 70-percent increase since the study’s inception in 2002. Because the cost of health care in retirement is growing so significantly, it can be among the largest expenses retirees face. HSAs can be an ideal retirement savingsoption to prepare for those expenditures.
Who Is Eligible to Open an HSA?
In order to establish an HSA, you must be covered by an eligible high-deductible health plan (HDHP). For 2018, this is defined as a plan for which the family’s annual deductible minimum is at least $2,700 ($1,350 for an individual), and the annual out-of-pocket costs are limited to $13,300 for family coverage ($6,650 for an individual). You can confirm with your health care benefit provider whether your plan is considered an HDHP that is eligible for an HSA.
Generally, you are not eligible to contribute to an HSA if:
- You are enrolled in Medicare.
- You are claimed as dependents by another taxpayer.
Contributions to an HSA may be made by you or your employers. Employer contributions made through a cafeteria plan are generally not income taxable. Your contributions to an HSA are considered “above-the-line” deductions. They can be claimed without itemizing, which is particularly important given the dramatic increase in the standard deduction under the 2017 Tax Cuts and Jobs Act.
Still unsure if an HSA is right for you? Give us a call and we can help you figure it out.