Health insurance savings should be on the top of everyone’s priority list with the massive increases in health insurance rates. Our health insurance costs have doubled over the past few years, so you’re not alone. In 2017 health care premiums are expected to increase 25% according to the U.S. government.
High costs may tempt you to not have health insurance. Medical bills are one of the biggest causes of bankruptcy, so that’s not a good option. And with the Affordable Care Act (ACA) you are required to be covered by health insurance.
Many employees now have access to health savings accounts (HSAs) to pay for qualified healthcare costs. Health savings accounts are tax-advantaged accounts that are part of high deductible health care plans (HDHPs).
You could end up with hundreds of dollars a month in health insurance savings with HSAs compared to using traditional expensive health insurance plans. Money that you can use towards getting out of debt or getting started investing.
But before I dig into how HSAs provide health insurance savings and how they work I’m going to set the stage for what we are facing as a society and how necessary health insurance savings is.
- How much health insurance savings will you need?
- What is a health savings account (HSA)?
- Why should you use an HSA for health insurance savings?
- What are the qualifications for an HSA?
- How much can I contribute to an HSA?
- How do HSAs work?
- How to make the most of your HSA
- If I’m in debt should I use an HSA?
- How to maximize your retirement savings with an HSA
- An overlooked IRS rule on HSA reimbursements
- How to invest in an HSA
- IRA rollover to an HSA
- Common Questions about HSAs
- Getting started with an HSA
Health insurance savings in retirement using HSAs
According to the Employee Benefit Research Institute couples should save $392,000 for health care costs by the time they retire. Yikes!
Fidelity says the average healthcare bills over a retired couples’ lifetime will be $245,000, assuming you live to age 85.
It doesn’t seem that far-fetched – if you’re retired for 20 years starting at age 65, and each person has $5,000 a year in out-of-pocket expenses, that’s $10,000 per year per couple or $200,000 over twenty years. That’s a lot of health insurance savings you need.
How much health insurance savings will you need?
The AARP has a medical savings calculator that can help estimate your health care costs in retirement.
I plugged in the numbers for my wife Katie and me, and the estimated shortage is $175,000 from what Medicare will cover. The total costs estimate is $517,000 during retirement. Medicare will cover $342,000.
$175,000 out-of-pocket is a massive amount of money. That’s a house! I guess you can sell your house to pay for your medical bills during retirement and go live under a bridge.
Or you can plan ahead and build up some health insurance savings for retirement and be ready by using an HSA.
Won’t the Imperial Federal Government save me?
When you hit age 65, Medicare, by itself, covers only about 60 percent of medical expenses.
Medigap, which is supposed to pay for what is left, does not cover expenses such as long-term care, in-home nursing or hearing aids.
Many retirees pick up Medigap policies to cover the difference or Medicare Part D for prescription drug coverage. But both of those policies cost money too – you need health savings to cover your health care costs in retirement.
What is a health savings account (HSA)?
Many employers have switched to high-deductible health plans (HDHP) as a cost-control measure for the rising costs of health insurance coverage.
For people with HDHPs there are special provisions in the tax code that allow you to set up a special health savings account to pay for qualifying medical expenses your HDHP doesn’t cover.
It was a nice way for the imperial federal government to screw you with costly health care plans, but give you a little carrot to make up for it.
With an HDHP you have access to health savings accounts (HSA) that you can use to pay for qualifying medical expenses, while at the same time getting some health insurance savings through some amazing tax benefits.
HSAs help balance out the higher deductibles by allowing for certain tax advantages. I’ll get to the tax savings in a bit.
HDHPs have high deductibles (as you would guess from the name high deductible health plan) with lower monthly premiums. Other health plans come with lower deductibles but higher monthly premiums.
Why should you use an HSA for health insurance savings?
If you’ve had to care for a sick parent or grandparent or you have the opportunity to ask them about their health care costs, the scary reality will set in – you need a boat load of money to pay for medical bills.
One reason to use an HSA if you have access to one is to pay your out-of-pocket medical costs during retirement.
But that’s nothing. It’s the tax savings you need to get in on.
Oh momma, the tax savings on these babies are wicked awesome.
Health Savings Accounts are an underutilized resource people aren’t using.
In fact, it’s THE best type of retirement account going right now.
- You get a tax deduction now
- Your money grows tax-free
- You can withdraw the money in retirement and spend it tax-free on qualifying medical expenses.
Compare that to qualified retirement plan (401k, 403b, 457b) or an IRA which only gets you two out of the three:
- You get a tax deduction now
- Your money grows tax-free
But with those plans when you withdraw the money during retirement that money is taxed at your ordinary income tax rate.
The money from the HSA you pay zero taxes on when you spend it on medical expenses. It’s a triple-tax savings. Plus depending on the plan you might avoid FICA taxes (social security and Medicaid) making an HSA quadruple tax-advantaged.
Do you think you will have medical expenses to pay for in retirement?
It makes sense to fund an HSA then if you can. There are some other benefits to HSAs as well. Let’s take a look…
Other HSA benefits to save money on health insurance
Besides the preferential tax treatment, there are several other benefits to HSAs.
Unlike with flexible spending accounts (FSAs) that are use-it-or-lose-it, your balance in your HSA rolls over year to year. The money keeps growing and growing if you don’t use it.
Take it with you
Your HSA is yours. When you leave your employer, change insurance plans or retire your HSA stays in your control. The money in your account continues to grow tax-free until you use it.
Pass it on
If you die (when you die) if there are funds left in your HSA they can be used by your spouse.
If you don’t have a spouse, the funds become part of your estate and can be passed on to your heirs or a designated beneficiary.
What are the qualifications for an HSA?
To qualify for an HSA you must:
- Be enrolled in a health plan that has a deductible of at least $1,300 per person (for the current year)
- Not be enrolled in Medicare
- Not be listed as a dependent on somebody else’s tax return
How much can I contribute to an HSA?
Before I get into HSAs and how they work, here’s a quick handy chart showing the minimum and maximum deductibles for HDHPs and the HSA contribution limits for 2017.
|2017||Minimum Deductible||Maximum Out-of-Pocket||HSA Contribution Limit||Catch-up (55+)|
2017 HSA contribution limits
You can contribute up to $3,400 per person (in 2017) to your HSA.
As a couple that’s $6,750 each year you can put away to grow tax-free.
How do HSAs work?
HSAs are simple to use. The money you or your employer contributes goes into an account. It’s like a checking account. You get a debit card. Here’s what mine looks like:
See where it says Visa Debit? It’s a debit card I can use for qualifying medical expenses everywhere Visa is accepted. Which is every doctor’s office, hospital, and pharmacy.
One of the most convenient ways to access funds in your HSA is with a health debit card. The card allows you to use the funds in your HSA for qualified expenses wherever Visa debit cards are accepted. It makes it easy to pay for things like:
- Dental: Cleanings, orthodontics, dentures
- Exams: Physicals, dermatologist
- Vision care: exams, new glasses, LASIK
- Hearing: exams and aids
- Medical equipment: blood pressure monitors, thermometers
- Smoking cessation programs
- Any qualified medical expense your plan doesn’t cover
Not sure if it’s a qualified expense? Most pharmacies, grocery stores or other places that sell healthcare products can check if a product or service is covered or not when you pay for them. You won’t be left scratching your head or wondering if the medicine you need to buy will be covered or not.
What I find I use it most for is calling the doctor’s office when I get a bill in the mail. I give them my HSA debit card number, and they take the payment out of my HSA.
You can’t use them to pay insurance premiums.
HSAs are grossly underutilized
According to a study by HelloWallet of 400,000 health savings accounts held by UMB Bank (one of the largest HSA record keepers in the U.S.) found some depressing statistics:
Only one in 20 account holders contribute the maximum allowed by the IRS, which is $3,350 a year for singles and $6,700 for a family (2016 limits), the report found.
Those that do participate are losing money
The money you put into an HSA can be invested or left in what’s the equivalent of a checking account earning 0% interest. Only 4% of participants invest their HSA money. The result is savings eaten up by inflation.
Where does my money go in an HSA?
An HSA is just a bucket, like a 401k or a checking account.
Like a 401k, it can hold stocks, bonds, cash, mutual funds, or whatever the HSA service provider offers for you to invest in.
If you treat your HSA like a checking account and spend the money out of it now because you need to – great. Your money will be there when you need it. It won’t earn any interest, though.
What if you treat your HSA like a 401k or part of your long-term retirement planning? You’ll want to put that money to work by selecting appropriate investments that will let your money compound over time. In the section below I go over in detail using your HSA as part of your retirement planning. But for now:
- Just like there are good investments and bad investments available in an employer’s retirement plan, an HSA may have good or bad investment choices.
- Some HSAs have very low-cost investment choices while others may have lousy choices that charge high yearly fees.
- You can screw up your HSA by making bad investing decisions, so it’s important to pick wisely.
How to make the most of your HSA
Deciding between insurance plans and picking one with higher premiums and a lower deductible vs. one with lower premiums and a higher deductible can be confusing.
HSAs require you to have a high deductible health plan. Is that a bad thing? I mean if you get sick you’re going to always have bigger out of pocket costs, right?
Well as with many things concerning money – it depends.
Being a good manager of money can help with health insurance savings. Say you’re like me and screw up your knee wakeboarding.
Ok, you probably don’t wakeboard.
Say you trip on the sidewalk and twist your knee.
Your primary care doctor is a quack, and tells you what you already know – “you hurt your knee!” You’ll need an MRI. He/she refers you to one of their golf buddies.
But you’re a savvy shopper. You call around to several MRI clinics and find out who is going to give you the best price.
Because you’ve got a big deductible and want the cheapest MRI you can get! Even if you have a smaller deductible, shop around for the best value to keep you under the ceiling of your maximum deductible.
Here’s the first site that popped up on Google when I searched for ‘save on MRIs’: Save on Medical
You have options in nonlife-threatening situations. Heading to the nearest 24-hour Emergency Clinic for a hang nail may give you some sticker shock.
If you know you’ll have to pay the full amount for a bill you’re more likely to shop around before deciding where to go. Consider if your health care plan has a $1,000 deductible or a $10,000 deductible. If you know in advance a visit or procedure may cost $800 it’s going to be 100% out of pocket either way.
Consider your stage of life
When deciding between health care plan with lower monthly premiums and high deductible or one with a lower deductible and higher monthly premiums you have to consider your stage of life and what’s going on.
Young and Living The Dream
If you are young, single, no kids and in good health, it makes good sense to pick an HDHP and contribute to an HSA. These are your prime years where you shouldn’t have many trips to the doctor or medical expenses. If your deductible is $3,000 for example, the chances of you having that much in medical costs are pretty low.
Getting Ready for Baby or Already With Young Kids
If you already have kids you know every rash or a runny nose can cause a trip to the doctor. An HDHP during this time of your life probably isn’t the best choice because you’ll have lots of doctors visits.
Likewise, if a new baby is in your future, there are going to be a ton of doctor’s visits and a hospital stay during birth. If you have complications (C-Section) or the baby is born pre-mature you’re going to end up paying all of your deductible out of pocket. You’ll need to ask yourself if you can afford to.
Financially it may make more sense to pick a health care plan with higher premiums and a lower deductible at this time.
The Fabulous Forties-And Beyond
Once the kids are out of the house and no longer a financial drain on your household, it’s time to visit getting on an HDHP and funding an HSA. If your feeling frisky and healthy, financially you might be in a position to meet the higher deductibles. The lower premiums will free up cash to throw in an HSA.
Take into consideration your family history of health. If your parents and grandparents had a history of health issues in their mid-years, you’d be running a financial risk if you find yourself in the same boat.
The majority of people in their mid–40’s don’t have two nickels to rub together. Having to shell out thousands in deductibles may put a bigger burden on already weak finances.
Do you have planned surgery?
A couple of years ago I ended up with a hernia from lifting too much weight at the gym. It was the beginning of the summer, and I asked the doctor if I could wait until the fall for the operation. He said sure as long as it didn’t bother me. I waited five months because I wanted to spend my summer wakeboarding, not sitting around healing from surgery.
Do you know if you’ll require a surgical procedure that is non-life threatening and can be delayed? Take the opportunity to push off the procedure to a time when you’re covered by a lower deductible plan.
If you’re in an HDHP with an HSA, max out your HSA this year so you can use the funds for future known medical bills. When you’re enrollment period is open, review if switching to a lower deductible plan will save you money. Knowing you’ll be going in for surgery and you’ll have to pay the full deductible, you could save thousands of dollars.
Figuring out the right contribution
As you’ll see in a moment, the right contribution is as much as you can afford to make.
Think about if you’ll be using your health care plan over the next year for known needs. Whatever that dollar amount try to fund your HSA with enough each month to meet your needs.
You’ll have to plan ahead. It’s easy to do – add up all your medical bills/prescriptions/co-pays from last year. Use your bank statements, credit card statements, and doctor’s bills to see what the total is.
If you’ve never done it before, be prepared for a rude awakening. The first time we did this it was a shocker how much money each month was going to health related expenses. It was and still is one of the largest budget categories for our house.
If I’m in debt should I use an HSA?
If you have access to an HSA because you have a high deductible health plan then YES you should 100% be using it.
Even if you’re in debt and with nothing saved for retirement you can get a tax benefit from using an HSA now.
Why? Because it’s almost guaranteed you’re paying some money each year for prescriptions or a visit to the dentist or doctor.
By paying the bills with your HSA now, you get a tax deduction for the current tax year.
Pre-planning to save on healthcare costs
Note that you’ll need to know in advance how much money you have spent in the past year on health care – otherwise you can’t maximize your tax savings.
You have to be tracking your expenses somehow or at least dig up the past 12-months of bank and credit card statements. Pick through the statements and add up what you spent on qualifying medical expenses.
Example of advanced planning
Let’s say in the last 12 months you spent $600 on health care. You must be super healthy because that isn’t much. You expect to spend the same amount over the next 12 months. If you have the full $600 on hand, deposit it into your HSA. When it comes time to pay your medical bills, use your HSA debit card and pay the bills with it. You need to make sure you have enough money in your HSA to cover the bill.
If you don’t have the full amount you think you’ll need on hand, add the money to your HSA as the bills come up.
Example of just-in-time planning
You’re going to get your teeth cleaned on the 1st of the month. Last time the dentist charged you $135.00. A week before you go to the dentist deposit $135.00 into your HSA. When you’re leaving the dentist’s office, and they hand you the bill, give them your HSA debit card for the payment. Or if you spent $600 over the last 12 months out-of-pocket on health care you could set up automatic deductions to your payroll or checking account to transfer $50 into your HSA each month.
You’re going to be paying those bills anyway. It isn’t negatively affecting your budget or your debt situation. And the benefit is you get a tax deduction now for the money you contribute to your HSA.
The tax savings will free up more money to pay down debts.
How to maximize your retirement savings with an HSA
Used properly an HSA can help you cover the significant medical costs you can expect during retirement. It starts with picking the right investments.
If you do not invest your health insurance savings within your HSA, it’s the same thing as leaving money in a checking account. You won’t earn any interest and the money will be safe, stored as cash. The risk you run is inflation will eat up your money over time.
Will you use your HSA for retirement?
You might feel intimated or confused by the investing choices you have in your HSA. If you’re a first-time investor or don’t understand the language – no worries. I’m here to help.
If you plan on leaving your money in your HSA for the long term (for retirement), pick the same type of investments as you have selected in your 401(k).
Picking what to invest in within an HSA is just like picking what to select in your 401(k), 457(b), or Traditional/Roth IRA. If you don’t know, please check out my article on how to get started investing.
Should I fully fund my HSA?
If you have your financial house in order and can max out your HSA, it makes sense to contribute the maximum allowed.
- Get any company match for qualified retirement plans (401k, Roth 401k, etc.)
- Fully fund your HSA
- Fully fund a Roth IRA
- If you have more money, go back and max out your employer’s retirement plan
In most situations, the above strategy helps you avoid as many taxes as possible while getting free money from employer contributions.
Don’t touch that money in your HSA!
What if you aren’t retired yet and have funds in your HSA? Should you pay out-of-pocket or pay out of the HSA?
Answer: Pay out-of-pocket if you can afford it and have the cash.
The tax-free withdrawals of HSAs are the number one reasons you shouldn’t pull money from them for any current expenses. Let the money grow and compound tax-free until you need it in retirement.
There are a couple more reasons to leave your HSA alone:
- If you use the money before age 65 for non-qualifying medical expenses you’ll not only have to pay ordinary income tax on the withdrawal; you’ll get hit with a 20% penalty.
- Studies show most people aren’t saving enough for retirement. Raid your HSA now, and you’ll wish later on you had left it alone.
It might seem like an odd thing to recommend – put money into your HSA, but don’t use it until retirement. If you treat your HSA as an investment account for retirement, you’ll most likely come out ahead.
We fully funded our HSA as part of our long-term retirement planning. Next year we won’t have access to an HSA as part of our new health care plan. We’ll let that money grow untouched in the HSA for the next 20+ years.
An overlooked IRS rule on HSA reimbursements
You might think you’re missing out by paying out-of-pocket and not using your HSA. You can reimburse yourself from your HSA for any qualified medical expenses you pay out of pocket – AT ANY TIME.
I put that in all caps for emphasis. You can pay for a medical expense out-of-pocket today. Then next month, next year, or even next decade – you can withdraw money from your HSA to reimburse yourself for past expenses.
And the reimbursement to yourself is tax-free.
Example reimbursement that illustrates savings
The best way to illustrate how this overlooked IRS rule for HSA reimbursements helps you with health costs savings is to start with an example:
Jadzia is 45 years old. She plans on retiring at age 65. At her current employer, she has access to a high-deductible health plan (HDHP) and an HSA.
Jadzia is married and fully funds her HSA each year. She ends up putting in $6,750 for 20 years.
There are a lot of assumptions here but I’ve got to keep it simple. I’m assuming she stays with the same health plan and the limits are never raised; she is going to work at the same place for 20 years, yada, yada, yada.
Jadzia is a good money planner for the family, and she figures they can pay their medical bills out of pocket each year. For her family of two (the kids have moved out) their out-of-pocket costs are $5,000 per year.
Over 20 years they will pay $5,000 X 20 years = $100,000 out of pocket instead of using their HSA to pay for any qualified medical expenses.
At age 65 through good investing the HSA has grown to $365,000. We assume she made 8% annually on her investments.
At age 65, Jadzia retires with $365,000 in her HSA.
She can begin to make tax-free withdrawals as a reimbursement for the $100,000 of medical expenses she paid out-of-pocket during the last 20 years.
Put another way – the $100,00 she paid out of pocket over the past 20 years can be withdrawn from the HSA tax-free at any time as a reimbursement to herself.
To make that work you’ll need to be a good record keeper. Every qualified medical expense you pay for out of pocket needs to be filed away for years – even decades. When the time comes at age 65 or later, you will have documented proof of the expenses and can reimburse yourself from your HSA. You don’t pay any taxes on the withdrawal.
If you’re left with a balance in your HSA, the same rules apply to the leftover savings. If you use them for qualified medical expenses at age 65 or later the withdrawal is tax-free. If you use the money for non-qualified expenses, you’ll pay ordinary income taxes without any penalty.
If you are younger than 65, as long as you paid for qualified medical expenses after you started your HSA, you can reimburse yourself or pay the expenses at any time with funds from your HSA.
The key is to keep track of your receipts. You’ll need to be able to show the IRS your records of what you paid. Also, you can’t double dip and pay for the expenses from another source. For example, if you are itemizing deductions and claiming medical expenses more than 2% of your AGI (I’m not a tax expert, I’m just throwing that out there).
Better than sliced bread!
The $100,000 Jadzia withdrew from her HSA to reimburse her medical costs over the past 20 years was tax-free. If she is in the 25% tax bracket, she just saved herself $20,000 in taxes.
What if she had just paid the money out of her HSA each year instead? It wouldn’t be any different than taking an early withdrawal from your 401(k) each year and spending it on candy, a vacation, or new clothes. The money never gets a chance to compound tax-free and grow and grow and grow.
By leaving the money in her HSA and investing it, the money compounded year after year. If she had paid the bills out of her HSA each year, instead of $365,000 in her HSA at age 65, she would have $0.
See the power of this strategy?
I want to plant that analogy because I think it’s so important. The benefits (there are many) of a tax-deferred retirement account is the money grows/compounds tax-free.
You would never pull money out each year to pay for a vacation, right? It defeats the purpose of investing.
Pulling money from your HSA defeats using it as one of the ultimate investing tools.
Please note – if you need the money from your HSA to pay for medical expenses – use it. However, if you can let the money grow – leave it.
It will take some fine money management and planning to swing it, but you can do it. Storing digital copies of your receipts, preferably online, so they are off-site will be beneficial. Paper copies of receipts are likely to fade after 20-years of storage. Print copies will also be at risk of being lost during moves or from the destruction of fire or water damage.
Does the IRS really allow this?
Yes, they do. Here is the language from the 2004 IRS Bulletin on health saving accounts:
Q-39. When must a distribution from an HSA be taken to pay or reimburse, on a tax-free basis, qualified medical expenses incurred in the current year?
A-39. An account beneficiary may defer to later taxable years distributions from HSAs to pay or reimburse qualified medical expenses incurred in the current year as long as the expenses were incurred after the HSA was established. Similarly, a distribution from an HSA in the current year can be used to pay or reimburse expenses incurred in any prior year as long as the expenses were incurred after the HSA was established. Thus, there is no time limit on when the distribution must occur. However, to be excludable from the account beneficiary’s gross income, he or she must keep records sufficient to later show that the distributions were exclusively to pay or reimburse qualified medical expenses, that the qualified medical expenses have not been previously paid or reimbursed from another source and that the medical expenses have not been taken as an itemized deduction in any prior taxable year. See Notice 2004-2, Q&A 31 and also Notice 2004-25, for transition relief in calendar year 2004 for reimbursement of medical expenses incurred before opening an HSA.
– You contribute $1,000 to an HSA in 2014.
– On December 1, 2014, you have a $1,500 qualified medical expense
– On January 15, 2015, you contribute another $1,000 to your HSA, bringing the balance to $2,000.
– In June 2017, you take a $1,500 distribution to reimburse you for the $1,500 medical expense you had from 2014
– You can show the $1,500 HSA distribution in 2017 is a reimbursement for a qualified medical expense that hasn’t been reimbursed and wasn’t taken as an itemized deduction.
The distribution is excludable from the account beneficiary’s gross income.
What minimum amount of money should I put in my HSA?
If you have an HSA its because you have a high deductible. Whatever that deductible amount is ($1,500 – $12,000) is the target amount you should at a minimum aim for to save in your HSA. Since most people have very little savings, you’ll want to keep that portion of your HSA in ‘safe’ savings.
How to invest in an HSA
I hope you realize you should invest in an HSA. I know you’ll recognize the huge tax benefits I outlined above. And I think you’ll agree every single person – no matter race, health, eating habits, weight, lifestyle – is going to have medical costs to pay for before they die.
And anything you can do to put yourself ahead of those bills and have more money to pay you should do.
The more money you have for medical bills, the more secure your retirement and financial future will be, right?
Now you’re probably wondering – ok, how do I do it? Investing can be very confusing.
Shameless plug here for my book which will cost you $0.99. I can’t possibly explain every aspect of investing in this article (what is the stock market, what is mutual fund, etc.) But my book covers 100% of those terms in a simple language that anyone can understand . And I priced it to get it in as many hands as possible.
Cash vs. investments
First, let me point out an HSA is just a bucket, not an investment. It doesn’t ‘do’ anything. It’s just like setting up a savings account at the bank. It just holds ‘stuff’ just like a bank savings account ‘holds’ cash.
You can divide up your HSA balance between cash and other investments.
Cash is low risk and low return. That’s a good thing if you want to make sure you always have enough cash to cover potential medical costs – like your big deductible.
Investment options vary between HSA custodians. If your HSA balance starts to exceed your known or planned medical costs (and your maximum deductible) it’s time to consider investing the extra and growing your money.
Should I invest the money in my HSA or keep it in cash?
You can also take the money in your HSA and invest it in higher risk/higher return investment options. What options are available depend on the custodian of the HSA (the bank or company managing it).
Some HSAs will give you access to invest in:
- mutual funds
- low cost index funds
- exchange traded funds (ETFs)
- real estate funds
What to invest in and in what percentages are beyond the scope of this article. You need to consider your
- risk tolerance
- when you will retire
- other available investment options
- current asset allocation of other investments
Again, I’m going to point you back to my book for an understanding of each of those topics.
Most HSAs have what’s called a money market fund to store cash. It’s a glorified savings account like you might have at the bank. It’s very low risk, and very low return. In 2016 most money market accounts will earn you 1% on your savings (most are closer to 0%).
Let’s walk through a few examples.
Example: Too risky
Ed and Pat are like most middle aged couples and haven’t started saving for retirement. Additionally, the would have a hard time coming up with $500 to pay for an emergency. The idea of an HSA appeals to them, though. They decide to max out their contributions. Instead of the low-risk money market account in their HSA, they put all of their money to work for them in higher risk investments.
The stock market tanks and their $6,000 HSA balance becomes worth $4,000. Pat gets in a car wreck, and they have to pay their $6,000 deductible out-of-pocket. They can cash out their $4,000 investment in their HSA to pay for most of the deductible but will have to find another way to come up with the remaining $2,000.
Example: Tight budget
Donna is a single mom on a tight budget. She recognizes the tax savings she can get by contributing to an HSA. Donna is healthy while she has a normal 5-year old that requires the occasional doctor’s visit. Donna saves $4,000 in her HSA and keeps it in a low-risk money market fund.
It doesn’t make sense for Donna to invest the money in her HSA in higher risk investments in case she has to pay her deductible. The better move is to save up enough in her HSA until the deductible is reached, then consider investing future HSA contributions so she can get a higher return on her money.
The stock market tanks, but it has no impact on Donna’s HSA balance. Her money wasn’t invested and was sitting in cash.
Donna’s child crashes her bicycle and breaks her arm. The ER visit costs Donna $2,500 out-of-pocket. Donna can withdraw the money from her HSA. Her remaining balance in her HSA is $1,500.
Example: Extra budget
Joel (age 30) and Tai (age 28) have a double income and no children. They are both healthy and have enough in a regular savings account to cover their high health insurance deductible if necessary. Joel and Tai plan on using their HSA for retirement. They fully fund their HSA and choose higher risk investments so they can maximize their returns over the coming decades.
The stock market tanks, but Joel and Tai go on with their lives. They know the market has ups and downs. The balance of their HSA goes down in the short term but will recover over time.
Tai gets food poisoning and makes an ER visit. Because Joel and Tai have the cash on hand to pay for the visit, they don’t touch their HSA balance. They didn’t have to sell the investments in their HSA for a loss to cover the medical bills.
Should you invest in an HSA or 401(k)?
HSAs can get even better! If you contribute to an HSA through pay deductions (subject to the type of plan), you don’t have to pay 7.5% FICA taxes. FICA taxes include the taxes you pay for Social Insecurity and Medicrap.
Let me walk you through the tax savings here using my favorite thing – nice round numbers.
First, you need to know 401(k) contributions are exempt from state and federal income tax, but NOT FICA taxes.
- Molly earns $50,000 a year gross.
- Molly contributes $10,000 to her 401(k)
- On Molly’s W–2 tax stub she will pay FICA taxes on $50,000, or $3,750
What if Molly decides to fund her HSA?
- Molly earns $50,000 a year gross.
- Molly contributes $6,250 to her 401(k)
- Molly contributes $3,750 to her HSA
- On Molly’s W–2 tax stub she will pay FICA taxes on $46,260, or $3,468
There are no FICA taxes on HSA contributions, so Molly saves $281 in taxes.
If a married couple maxed out their HSAs ($6,750 per year) instead of contributing the money to a 401(k), they could avoid paying $506 in taxes each year.
While you can avoid FICA taxes by contributing to an HSA instead of a 401(k), there is more to the decision than that.
Note: Your situation is specific to you. I’ll give you some things to think about so you can make your own informed decision or know the questions to ask your tax or investment advisor.
What if your employer has matched 401(k) contributions?
If your employer has a 401(k) match you should at least get up to the maximum match. For example, if they match dollar for dollar up to 3%, contribute at least 3% to your 401(k).
If you still have money left over to invest the next best option is probably an HSA. Max out your HSA to the allowable contribution limit.
If you have a limited amount of savings to invest, consider dividing the amounts between an HSA and another investment bucket.
What if your employer does NOT have matching 401(k) contributions?
If you can fund your HSA with pre-tax contributions, the HSA might be the better choice. If you don’t use the money for qualified medical expenses and withdraw funds during retirement, the taxation will be no different than a 401(k).
But you’ll get the added tax reduction of not paying FICA taxes on an HSA if it’s done through a qualified employer plan.
Plus with the HSA you can use the money at any time for medical expenses tax-free and penalty free. If you had huge medical bills and were looking to cover the costs by withdrawing early from your 401(k), you would pay federal and state income taxes, plus a 10% penalty.
Cashing out $50,000 in 401(k) savings may leave you with only $35,000 after 20% withholding and a 10% early withdrawal penalty.
A 401(k) loan would be another bad scenario. You would pay interest on the loan, and if you had to leave the company or were let go, the loan would immediately become due.
The HSA is the clear winner for many situations.
If your employer has HSA and 401(k) matching
If you’re single and can only put away $3,000 per year of your salary into one of these defined contribution programs, it makes more sense to do a 401(k) if you can get an employer match.
But you also have to consider how much the match is. If an employer matches 3% of your HSA contribution but only 1% in your 401(k), you get more free money contributing to the HSA if you contribute up to the 3% match.
Should you invest in an HSA or Traditional IRA?
When choosing between a Traditional IRA or HSA, it’s a no-brainer – the HSA.
The HSA and Traditional IRA have many similarities that benefit you:
- Reducing your income taxes now
- Tax-free growth of your money
But during retirement is when the HSA shines. If you use the money for qualified medical expenses, you spend the money tax-free.
If you were to withdraw money from a traditional IRA to pay for medical expenses, the withdrawal would be taxed at your ordinary income tax rate.
Not to mention if you saved your receipts over the years. You could reimburse yourself and not pay any taxes on the money withdrawn to reimburse yourself.
The HSA wins choosing between a Traditional IRA and HSA.
Warning: When you can withdraw money is different for IRAs and HSAs. You can withdraw money from an IRA at age 59 1/2. Anytime before age 59 1/2 and you’ll have to pay a 10% penalty.HSA funds cannot be withdrawn for non-qualified medical expenses before age 65. If you withdraw money from your HSA before age 65 and spend the money on a vacation or to pay the rent, you’ll get hit with a 20% penalty.
So you have to do some planning to avoid the early withdrawal penalty before age 65 if you’re going to need the money from an HSA for something other than medical bills.
What if you have limited funds to save?
If you need to use the HSA money at any time before age 65 for planned or unplanned medical expenses you can withdraw the money tax-free and penalty free.
Consider if you’re on a budget without any extra money left over each month to save up for retirement. A situation comes up where you need money for unexpected medical expenses. Or maybe you have a planned medical expense like Lasik eye surgery. In either case, you’ll have access to your HSA money and can withdraw it tax-free.
If you don’t need the money, it can stay invested and grow just like it would in an IRA. If you stay healthy, the money can grow. But if you are on a limited budget and need the money for health care, it will be available to you.
Should you invest in an HSA or Roth IRA?
The Roth IRA is considered one of the best investment options for young people because the money grows tax-free and can be withdrawn tax-free during retirement.
If you’re in your 20’s or 30’s you should be worried about tax rates being higher 30–40 years from now. And frankly, if you start investing in your 20’s and 30’s you should have a boat load of money in your 60’s. Which makes you target to pay out the nose in taxes and get reduced social security benefits. You will get penalized for being a good saver.
A Roth IRA doesn’t reduce your current federal income taxes. Roth IRAs are funded with money after you pay your taxes.
Because you are likely – I would argue guaranteed – to have out-of-pocket healthcare costs during retirement, maxing out your HSA up the allowable contribution limit seems like the better idea before funding a Roth IRA.
Even though Roth IRA withdrawals are tax-free, qualified medical expenses paid with your HSA are also tax-free. And remember earlier the estimates were people will need over $200,000 on average to pay out-of-pocket medical costs during retirement (assuming living age 65–85).
Since you are certainly going to need money for health care someday, it can make sense to fund an HSA even before a Roth IRA.
Once you fully fund an HSA, then you would look at other investment choices.
Other considerations when deciding between an HSA or 401(k)/403(b)/457(b)/Traditional IRA
Another consideration is the investment options available. If the HSA provider is charging big fees, it might be better to stick with the 401(k).
You’ll need to look at all of the considerations before making the best financial choice:
- Employer matching in employee retirement plans
- Employer matching in HSAs
- Investment options in employee retirement plans
- Investment options in HSAs
HSAs and required minimum distributions (RMDs)
When you get to age 70 1/2 the imperial federal government demands you take money out of any:
- Traditional IRA
- IRA based plans (SEP IRA, SIMPLE IRA)
- Roth 401(k)
Roth IRAs do not have required minimum distributions.
HSAs do not have required minimum distributions either.
Not having required minimum distributions is another important feature when doing your retirement planning. If you collect social security and are forced to take an RMD, you could be bumped into a higher tax bracket.
Because an HSA has no required minimum distribution, you can withdraw as little or as much as you need whenever you need it (after age 65 without penalty).
The longer the money in your HSA can grow tax-free the more money you will have to pay insurance premiums, co-pays, medical expenses, etc. in your later years.
Think about it – say you look at your family history and find everyone is checking out at age 85. An HSA account with no required minimum distributions can grow for 10, 15, 20+ years with continued tax-free growth.
Are employee contributions to HSAs subject to FICA taxes?
Here’s where the rules vary.
According to the IRS, contributions to an HSA are not subject to withholding of FICA taxes if the employer has a cafeteria plan in place that provides for HSA contributions.
Yes, more IRS garbage rules that provide benefits for some and penalize others.
Unless the employer’s plan is specifically a cafeteria plan as defined by the IRS, you pay FICA on it. To find out if your employer’s HSA plan is cafeteria style, you’ll have to ask your HR or benefits person.
Self-Employed – No Soup For You
If you are self-employed and contribute to your own HSA – sorry, there is no FICA avoidance. You will pay FICA taxes on any HSA contributions.
IRA rollover to an HSA
It’s another gift from the IRS!
If you have an IRA, you’ve already received the tax deduction on it from your income.
- The money will grow tax-free
- You’ll pay taxes at your ordinary income rate when you withdraw the money in retirement.
But remember with an HSA if you withdraw the money during retirement and pay for qualifying medical expenses the withdrawals are tax-free!
The imperial federal government has a special provision that allows you to make a once-in-a-lifetime transfer from a traditional IRA to your HSA. If you do this, you’ll avoid paying any taxes on that money (qualifying medical expenses, blah blah blah).
The rules for doing this are:
- You can do this once in your life
- You can only rollover up to the maximum HSA contribution limit
- If you’ve already contributed to an HSA you have to subtract that amount from the rollover
- You must be enrolled in the HSA for 12 months after the transfer to avoid any penalties.
The timing of the rollover is very important.
If you are leaving your high deductible health plan in the next 12 months, the IRS treats the HSA rollover as a taxable withdrawal. So don’t do it if that’s on the horizon. Even though you’re putting money in an HSA, you’ll get hit with a 10% early-withdrawal penalty if you’re under age 59 1/2 and you’ll pay ordinary income taxes on the amount transferred.
For example, if it’s June and you know in six months you’ll be switching to a Health Share service (which is not an HDHP) you would not want to do a traditional IRA to HSA rollover.
However, if you were:
- had at least $6,750 in a traditional IRA
- are enrolled in an HDHP
- plan on being with your current employer for the next 12 months and not changing your health care plan
- have not fully funded your HSA for the year
You would absolutely want to look into doing a rollover to save taxes during retirement.
Tax savings from an IRA rollover to an HSA
If you had an HSA with $0 in it, you could save $1,300 in taxes if you were in the 20% tax bracket. The savings will depend on your tax bracket during retirement.
The best thing to do is speak with your IRA administrator, your HSA administrator, and your tax preparer.
One-time lifetime rollover limit
You can only do a traditional IRA to HSA rollover once in your life. It’s best to wait until you can transfer the maximum amount possible.
If you’ve already contributed $5,000 towards your $6,700 yearly HSA, limit it’s almost pointless to rollover $1,700 from a traditional IRA. You would want to wait for a year when your HSA contribution was zero or low so you can transfer as much as possible.
The timing is tricky, but it can save you big bucks in taxes. For more information about the tax rules for the rollover written in the wonderfully clear writing of the government, check out the IRS website
Rollovers and Trustee transfers
A trustee to trustee transfer of an HSA is when you move your HSA account from one place (trustee) to another.
It would be like changing banks.
You can do a trustee to trustee transfer as often as you wish. HSA trustee to trustee transfers doesn’t have the same restriction as an IRA rollover to an HSA.
What if I have a Roth IRA?
Nope, don’t do it. If you already have a Roth, the money is growing tax-free and can be withdrawn tax-free. When you withdraw that money, it can be used for anything.
Money from an HSA can only be withdrawn tax-free for qualifying medical expenses. The HSA limits you on what the money can be used for.
Plus if you have a Roth IRA you can at any time withdraw the contributions penalty free (even before age 59 1/2). Not so with an HSA.
I have no idea why the IRS would allow this type of conversion. It’s a terrible financial move. But hey – that’s government!
Common Questions about HSAs
Can I contribute to an HSA if I’m over age 65?
Once you hit age 65 and on Medicare, you can no longer contribute to an HSA. But you don’t lose any of the savings you’ve already put in an existing HSA account.
Will I lose the money in my HSA if I don’t use it?
Flexible Spending Accounts (FSAs) are ‘use it or lose it’ accounts where if you don’t use all of the funds in a calendar year they don’t roll over to the next year. You lose whatever money you don’t use.
HSAs aren’t like that (yay!). The money continues to accumulate in an HSA until you use it or die.
The HSA will become part of your estate and pass to any beneficiaries when you die. The beneficiaries will be responsible for any taxes.
If you have a spouse they become the owner of the HSA and can treat it as their own HSA (assuming they are the beneficiary).
Are there employer matches to HSAs?
Some employers offer matching yearly contributions to HSA accounts while others may give you a sign-up bonus. Employers might match your contribution or a percentage of your contribution.
According to Fidelity, it’s not unusual for employers to kick in $500 for singles and $1,000 for families into an HSA to encourage you to sign up. That’s free money! Check with your employer to see if there is a sign-up bonus.
HSA Wellness Contributions
Employers might also contribute money if you participate in a wellness program or take a health assessment. If an employer has a wellness initiative, you might get additional HSA contributions by meeting the wellness standards.
Example: Nissan – I’ve had Nissan employees email questions into my show. I’m amazed at the incredible benefits Nissan provides its employees.
The LiveWell program includes two components – a Consumer Driven Health Plan with a Health Savings Account (HSA) and Health Improvement Programs. Nissan provides HSA funding for participation in health improvement activities (wellness programs and disease management) and personal improvement activities (such as participation in weight-loss programs or regular physical activity).
Can I use the funds from my HSA for non-medical expenses?
If you need money in retirement, you can take it from your HSA and the withdrawal will be treated just like a 401k or IRA withdrawal. You won’t pay any penalties after age 65, and the money is taxed as ordinary income.
But again, if you have other money use that first and keep the HSA for medical expenses. If you do that you avoid paying taxes.
Are there catch-up provisions?
If you are aged 55 or older, you can contribute an extra $1,000 per year to your HSA. If you have the extra money, it’s important to do this. Most people are far short of their health savings.
In what order should I take retirement distributions?
If you have multiple sources of retirement savings or income:
- social insecurity
- employer plans
- rental income
- part-time work
Saving thousands in taxes is where paying a good tax professional pays off. And I’m not talking about the temporary Walmart employee that do your taxes for you. Also, skip the popup shops that move into the corner strip mall starting on January 1st and close up on April 15th.
You want a good tax professional. One that is a:
- licensed tax consultant
- or financial planner that does tax projections
Ask your friends for a recommendation or do some Internet research for someone in your area. Talk to several people before deciding.
The money you pay someone for good advice can save you thousands in taxes. Don’t think you can get that advice for $50.
Make sure you read up on your situation as much as you can on the Internet. With a basic understanding of your retirement accounts, you’ll be able to ask better questions – and get better answers.
There is no one-size-fits-all answer to the question.
- If you’re younger than 59 1/2 you have to consider early withdrawal penalties
- If you’re age 70 1/2 or over you have to consider required minimum distributions
- When you start collecting social security and how much you need to live on are factors
- Your health is a consideration as well
- Your tax bracket during each year of retirement will be critical in reducing your taxes
Here are some considerations with an HSA when doing retirement planning:
HSA’s don’t have required minimum distributions
At age 70 1/2 you will be forced to make withdrawals from traditional IRAs/401(k)/403(b)/457(b). RMDs can bump you up into a higher tax bracket when added to your social security benefits.
Note: Some people argue nobody has saved enough ever to get bumped into a higher tax bracket during retirement. That’s flat out wrong. Check out this story of Neil Malling, 71, of Portland, saw his marginal tax rate just about double after he withdrew $9,000 from his traditional IRA, as required by law.He and other seniors fall victim to quirks in the U.S. tax code that suddenly increase the amount of Social Security benefits subject to tax.
HSAs can be used as a traditional IRA after age 65
Once you’re 65, you can take penalty-free distributions from your HSA for any reason. Withdrawals for non-medical expenses are treated as ordinary income, just like a traditional IRA.
HSA reimbursements are tax-free
For any medical expenses, you can take a withdrawal and reimburse yourself tax-free. Keep your receipts and pay yourself back tax-free whenever you need some tax-free income.
Getting started with an HSA
Get Started Now! Open an HSA and put in the minimum balance as soon as you can once you’re allowed to based on the effective date of your HDHP. You can’t take advantage of the tax-free benefits until your HSA is open.
If you plan on reimbursing yourself for medical expenses later, only medical expenses that occur AFTER your HSA is opened are eligible.
Even if you can’t contribute a significant amount or max out your HSA, at the very least open one and keep a minimum balance. Later on, contribute more if you’re financial situation allows it.
Many employers offer HSAs as part of their benefits package. If you have a high deductible health plan but your employer doesn’t offer an HSA you can set up a private HSA for you or your family.
If your employer doesn’t offer any matching, you might be better off with a private company HSA anyway. With a private HSA, you’ll probably get better investment options to pick from which can save you money over time.
HSA Search is a tool you can use to compare different HSA providers and read reviews about them before you pick one.
What Should Look For When Choosing an HSA?
If you have a high-deductable plan, you’re eligible for an HSA. If your employer offers you an HSA, that doesn’t mean you have to use it.
You are free to choose an HSA of your own through any financial institution that offers one.
It’s very similar to picking a 529 college savings plan.
Which might make you nervous because now you have to figure out:
How do I pick an HSA?
If your employer offers any matching contribution the choice is easy – go with your employer’s HSA plan. You don’t want to miss out on that free money.
If your employer doesn’t offer matching contributions, you may be better off picking a plan with someone else. When you’re choosing an HSA on your own here’s what to look for:
Low costs. Some HSA’s have annual fees to maintain your account. If you add a small amount to your HSA each year – $1,000, you don’t want to have to pay $100 each year in fees. That’s 10% of your money which is ridiculous. Look for small monthly/annual fees that don’t eat away your savings.
HSAs have not yet gotten the same scrutiny as 401(k) plans. The new Department of Labor rules impose more transparency on 401(k) fees, but HSAs are currently left behind. Make sure you know what you’re going to be charged in fees.
Investment choices. One listener to my show had an employer HSA with no investment choices. It was a plain old saving account earning no interest. You want to be able to invest your savings over time, so they grow. Pick a plan with low-cost index funds like those found at Vanguard (no affiliation).
Automatic deposits. You’ll save more and save more often if the company pulls money from your checking account each month and automatically adds it to your HSA. If you have an employer plan, they should have automatic deposits just like your employer-sponsored retirement plan.
Ease of use. Providers that issue a debit card give you an easy way pay for expenses. Look for debit cards or a checkbook, as well as how much the fees are.
Interest rates. Until you invest your HSA funds, they will sit in a savings account at your HSA trustee. What is the interest rate they are paying on that money?
Online management. With my provider I can login to my HSA at any time and see my account balance, withdraws, change my investments and my transaction history. It’s very easy to use and gives me a simple way to make one-time deposits or setup automatic recurring deposits to increase my health insurance savings.
If you plan on using your HSA as part of your retirement planning, the costs and investment options are the most important considerations when selecting a provider. The costs can add up over time, and that’s money that won’t compound for your retirement savings.
There isn’t a better investment option around that comes with the quadruple tax advantages of an HSA.
- tax deductible contributions
- tax avoidance (FICA)
- Tax-free growth
- Tax-free withdrawals
To make this retirement income strategy work for you all you need to do is sign up for an HSA (if you can swing the HDHP), save and invest through the HSA, pay your medical expenses out of pocket and hang on to your receipts for a really long time.
Then kiss the tax-man goodbye!
If you have question you would like answered on HSAs; please email me at firstname.lastname@example.org