Financial Advice for Retirement, Social Security, IRAs and Estate Planning

Key Retirement Advantages of Health Savings Accounts (HSAs)

The Health Savings Account (HSA) could be the best retirement planning vehicle available. Only the Roth IRA comes close.

People are catching on to the advantages. There are now over $40 billion in HSAs; over the last year alone, the number of HSAs increased by 16%.

Much of the increase comes from employers switching to high-deductible health plans, where HSAs are designed to supplement those plans.

Yet, people aren’t reaping all the advantages of Health Savings Accounts.

The best way for most people to use a HSA is as a retirement savings vehicle.

During the working years, it’s best to pay for medical expenses out of income and non-HSA savings when possible.

Let the HSA accumulate and compound for retirement.

The Health Savings Account is the only savings vehicle with three tax advantages:

#1. There’s a tax advantage when money is contributed to the account. When you make a contribution, it is tax deductible.

When your employer (or anyone else) contributes to your Health Savings Account, the contribution is tax-free to you.

Unlike when you defer salary to a 401(k), the HSA contribution isn’t even subject to Social Security and Medicare taxes.

#2. The second advantage is that the Health Savings Account can be invested, and the income and gains aren’t taxed while they remain in the account.

#3. The third advantage is that distributions from the Health Savings Account are tax-free when used to pay or reimburse you for qualified medical expenses.

That’s because you’re likely to pay more in medical expenses during retirement than your working years.

It makes sense to do some of your retirement savings through a HSA. Then, during retirement, begin taking tax-free distributions as needed to pay medical expenses.

Qualified medical expenses would be deductible as itemized medical expenses on your income tax return. It can pay for expenses not covered by Medicare or other insurance, including dental and vision expenses.

The account can pay Medicare Part B premiums, even if they are deducted from your Social Security benefits. Simply reimburse yourself for the premiums.

Premiums for Part D prescription coverage and Part C Medicare Advantage plans also qualify as tax-free distributions. But premiums for Medicare Supplement (Medigap) plans aren’t qualified medical expenses.

If you have questions about qualified medical expenses, review the free IRS Publication 502, available at www.irs.gov, or ask your Health Savings Account administrator.

Health Savings Accounts have advantages in addition to the big 3 tax benefits.

There are no required minimum distributions. The Health Savings Account balance can accumulate until you need it.

The HSA can pay for nonmedical expenses. When distributions from an HSA are used to pay for anything other than qualified medical expenses, the distribution is included in gross income, but there’s no penalty if the distribution is at age 65 or after.

There’s an additional 20% penalty when you’re under age 65 and you take a distribution for non-medical expenses.

When you pass away, the account balance goes to the beneficiary you named. The tax treatment depends on who your beneficiary is.

When you don’t name a beneficiary, and name your estate, the HSA will be distributed to your estate. The entire amount will be included in gross income on your final income tax return.

There’s better treatment when your spouse is the beneficiary. The account will remain a HSA, and your spouse will be its new owner.

Distributions to pay or reimburse qualified medical expenses will continue to be tax-free. When your spouse is 65 years or older, distributions for non-medical expenses will be included in gross income. When your spouse is under age 65, distributions for non-medical expenses will also face a 20% penalty.

When the beneficiary isn’t your spouse, the account stops being a HSA on the date of your death.

The account balance is distributed to the beneficiary and included in gross income. Any qualified medical expenses you incurred before passing, that the beneficiary pays within one year of your death, can reduce the taxable amount.

A Health Savings Account can be opened only when you are covered by a high-deductible medical insurance plan, whether it is through an employer or an individual policy.

Not all “high deductible” insurance plans qualify you to open a HSA, so it’s important to verify with the plan administrator or insurer that it is a HSA-eligible plan.

Despite the rising use of Health Savings Accounts and their many benefits, too many HSA owners don’t reap all the advantages of their accounts.

Like an IRA, a Health Savings Account has to be maintained by an administrator or custodian, and each offers different terms.

When opening an individual HSA, carefully choose the administrator or custodian.

Morningstar did a study of major Health Savings Account providers recently and was unimpressed. Some charge monthly fees that can quickly eat away the value of the HSA. Others offer very limited investment options.

Check the investment choices and any fees associated with them.

Many people have their HSAs invested in cash. While you don’t want to take a lot of risk with the account (unless you’re fairly young and believe you won’t need the money for years), you should consider investing to earn a little more than cash.

Also, investigate the spending and reimbursement options. Many Health Savings Accounts now offer a free debit card and a checkbook.

You can pay for medical expenses by using either the debit card or the checkbook. Checks can also be used to reimburse yourself for covered expenses you paid.

You also might be able to link the HSA with one or more of your other financial accounts. For example, after incurring a qualified expense, you can transfer money to your checking account, either online or by telephone.

While many custodians offer those easy ways to take tax-free distributions, some don’t. Some HSAs require you to complete a distribution request before they’ll issue a payment.

I recommend taking a look at HSA Bank and The HSA Authority. Each is a relatively small bank that offers HSAs with good terms nationwide and good investment options. Also, consider Health Savings Administrators.

The maximum contribution in 2018 is $3,450 for an individual policy, or $6,900 for a family policy. Account owners who are 55 or older can add $1,000 to those limits.

There’s an IRA rollover option available to someone who wants to fund a HSA, but doesn’t have the cash.

You can roll over from a traditional IRA to a HSA an amount up to the year’s annual contribution limit. The rollover will be tax-free.

But this option can be used only once in a lifetime, and the rollover, plus any other contributions for the year, can’t exceed the year’s contribution limit.

As you reach age 65, you should know that once you enroll in Medicare, no contributions to your HSA are allowed.

Most people need to enroll in Medicare at age 65 to avoid paying higher premiums for life by signing up later. In addition, you’re automatically enrolled in Part A when you file for Social Security retirement benefits.

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