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One of the most powerful tools in retirement planning is one I find many clients resist using and that is the High-Deductible Health Plan (HDHP) with a Health Savings Account (HSA). Clients are reluctant to make that shift from a traditional medical plan to the HDHP with an HSA because of the higher out of pocket costs associated with higher deductibles. I find those that do make the shift often wish they had made it sooner once they have had a few years of savings built-up in their HSA and they see the long-term benefit of using the HSA as an additional retirement plan.
Do not confuse the HSA with Flexible Savings Account (FSA), which allows an employee to set aside pre-taxed dollars for qualified medical or dependent care expenses. However, money in an FSA that is not spent during the plan year is generally forfeited to the plan. There are some exceptions to this use it or lose it rule for smaller amounts that can be carried over if the employer allows for it. Additionally, there is a grace period that can last up to 2 ½ months at the start of a new plan year to use any remaining funds from the previous plan year for new expenses incurred. The bottom line is that the FSA is meant to help with current year medical expenses and is not designed to be a savings account like the HSA. ADDED FLEXIBILITY IN RETIREMENT INCOME PLANNING The key to turning your HSA into a retirement account that turbo charges your retirement savings and provides added flexibility in retirement income planning is to be able to pay your premiums, contribute to your HSA, and pay medical costs out of pocket. Granted this can be expensive, but the long-term benefits are undeniably powerful. In 2023, you can contribute up to $3,850 if you have health coverage just for yourself or $7,750 if you have coverage for your family. In 2024, contribution limits will increase to $4,150 for individual coverage and $8,300 for family coverage. Additionally, if you are 55 or older you can contribute an additional $1,000 catch up amount. In total, you could contribute up to $9,300 if you have a family plan in 2024. In comparison, you can contribute $7,000 to an IRA with an additional $1,000 catch up contribution totaling $8,000 if you are 50 or older. For individuals who cannot contribute to a Roth or deduct a Traditional IRA contribution, the HSA is potentially a better option. BEWARE POTENTIAL DRAWBACKS One of the drawbacks to the HSA is if you take money out before you are 65 for non-medical costs, or medical costs that do not qualify, you will be subject to paying the federal income tax and a 20% tax penalty. While this is a hefty price to pay, there is one simple way to minimize the potential of being subject to the burden of this double whammy of taxes and penalties. Qualified medical expenses that you incurred and paid out of pocket since you opened your HSA are still eligible to be withdrawn tax free years later. Thats right, save those paid medical bills for future use to avoid any taxes or potential penalties. Unless you are unbelievable healthy and do not have current qualified medical expenses or prior qualified expenses that can be withdrawn, you should be able to avoid taxes and any penalties prior to 65. If you are lucky enough to find yourself in the unlikely situation that you have no qualified medical expenses to avoid such penalties and taxes, there is still good news. When you reach age 65, you can withdraw money penalty free for any reason. Basically, your HSA is treated no differently than a Traditional IRA for non-qualified expenses after age 65, so you will only have to pay ordinary income taxes. If that was not enough, HSAs are not subject to minimum distribution rules like of other retirement plans such as 401k, 403bs, 457bs and Traditional IRAs. ARE YOU ELIGIBLE FOR THIS VALUABLE TOOL? In the end, the HSA is a valuable tool that allows you to save money for retirement and medical costs in the most favorable way and offers great flexibility when developing strategies for generating income in retirement. There is a lot to consider before changing your health plan such as your personal health situation and financial circumstances. There are also eligibility requirements. For example, you cannot contribute to an HSA once you enroll in any part of Medicare. Talk to your benefits manager to see if your employer offers an HDHP with an HSA, confirm your eligibility, look at your spending patterns over the past few years including premiums and out of pocket expenses, understand how your plans coverage works, and talk to your financial advisor to see how a change like this would affect your cash flow and long-term savings goals. If you have any questions or want to learn more about the role of an HSA in your retirement plan, feel free to Contact Us to speak with one of our advisors.
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