The Retirement Advantages of Health Savings Accounts

There’s an advantage in the medical insurance changes of the last few years, and few people are maximizing it. The Afford-able Care Act of 2010 of course changed insurance for pre-retirees, whether they buy individual policies or have employer-provided coverage, and you need to know how to use the changes to your advantage.

The major change is the switch to high-deductible plans in both employer-provided and individual policies. Premiums increased significantly for many, and the best way to reduce premiums is to increase deductibles. The insurance covers fewer routine expenses. The individual pays those out-of-pocket.

A high-deductible policy has advantages and disadvantages, but often carries with it eligibility for a health savings account (HSA). An HSA is a valuable financial tool that isn’t exploited by many who are eligible. Your insurer can tell you if the policy makes you eligible for an HSA. If you’re married and your spouse has separate medical coverage, check the rules carefully to see if you’re eligible to open an HSA and qualify for the full annual contribution.

More than a way to pay for current medical expenses, the HSA can be an important part of your retirement planning. Properly used it often is better than a 401(k) or even a Roth IRA as a planning tool. I believe the advantages of an HSA for retirement planning are so significant that reasonably healthy people who haven’t been forced into HSA-eligible coverage should seriously consider switching to such coverage and maximizing use of the HSA.

The basics of an HSA are simple. Either the account owner or his or her employer makes contributions to the account. (Actually, like a 529 college savings plan, anyone can make deposits into your HSA.) The deposit is deductible from gross income if you make it or excluded from your gross income if the employer makes it. The maximum contribution in 2015 is $3,350 for an individual policy or $6,650 for a family policy. Account owners who are 55 or older add $1,000 to those limits. The account can be invested in anything the account administrator allows, and investment earnings of the account compound tax-free.

Here’s the second big pay off. When distributions are taken from the HSA for qualified medical expenses, the distributions are tax free. So, the money is tax-free or deductible going into the HSA, and tax-free coming out when used to pay for qualified medical expenses.

Qualified medical expenses are those that are deductible as itemized expenses on your tax return if you had paid for them with after-tax dollars and they weren’t reimbursed by insurance. That means an HSA can pay for expenses that aren’t covered by many medical insurance plans, such as dental and vision care.

The idea behind an HSA was that you would have the high-deductible policy and use the HSA to pay for deductibles, copayments, and noncovered expenses as they are incurred.

A better strategy is to let the HSA accumulate for your retirement years. Pay current medical expenses from your income, unless some major catastrophic expenses are incurred. Then, use the HSA in retirement to pay for expenses not covered by Medicare, premiums for Medicare supplemental insurance (Medigap) and Part D prescription coverage, and any medical expenses not covered by them.

The HSA also will be available to pay for nonmedical expenses if you need it. When distributions from an HSA are used to pay for other than qualified medical expenses, then the distribution is included in gross income. In that case it works just like a traditional IRA, except there aren’t required minimum distributions.

If there is a balance in your HSA when you pass away, the balance is inherited by your estate or a beneficiary you designated with the administrator.

You need to choose an administrator for your HSA, just as you need a custodian for an IRA. Take a look at HSA Bank (hsabank.com), which allows accounts above a minimum balance to be invested through TDAmeritrade, and Health Savings Administrators (healthsav-ings.com; ignore the hyphen), which allows investments through Vanguard. As with IRAs and other financial accounts, look for low fees, investment options, and any other features that are important to you, such as robust online tools or good telephone customer service.

Most HSAs now offer a free debit card that you can use the same as any other debit or credit card to pay for medical services (or anything else if you want to incur the taxes). Most will issue checks that are just like regular bank checks, but for an additional fee. You also can issue payments or transfer funds to one of your other financial accounts either online or over the telephone.

As you reach age 65, there’s a tricky interplay between HSAs and Medicare to be aware of.

You’re generally required to sign up for Medicare at age 65 unless you meet one of the exceptions, and you’re required to sign up for Medicare Part A when you file for Social Security retirement benefits. There’s also a rule that once you sign up for Medicare, contributions to an HSA no longer are allowed. Neither personal nor employer contributions are allowed.

This means that after age 65 you can’t have additional contributions to an HSA if you work past age 65 for an employer with fewer than 20 employees (including being self-employed), an employer whose plan doesn’t meet the Medicare exemption requirements, or an employer whose plan requires you to sign up for Medicare at 65 and have it become the primary insurer. You can leave money in the HSA and use it as already described. The only change is that new contributions have to stop.

This rule has to be considered when planning your Social Security benefits strategy. For example, you might be planning to delay benefits until age 70 to maximize them. But you also might consider the file-and-suspend strategy we’ve discussed in the past under which you file for Social Security retirement benefits but immediately suspend them. This enables your spouse to collect spousal benefits on your earnings history. Depending on the level of Social Security benefits involved, this might or might not be worthwhile if it costs you five years of HSA contributions. You’ll have to do the math or work with a financial planner to make the decision.

The Medicare/Social Security interplay shouldn’t keep you from opening an HSA and maximizing its value through age 65. But you have to realize that the HSA contributions have to stop when you file for Social Security benefits or at 65 if you’re required to enroll in Medicare.

RW April 2015.