HSA: Three Letters That Offer A Triple Tax Benefit

By Sally Hanley-Whitworth, CFP® | Executive Vice President, Wealth Services | 11.07.2018

Traditional IRAs give savers the opportunity to make tax-deductible retirement contributions. Roth IRAs let retirees withdraw their savings tax-free. Both vehicles let invested savings grow without generating any taxable gains. That’s two tax benefits apiece for anyone keeping track.

Health savings accounts (HSAs) up the ante on these traditional retirement-saving vehicles. They combine the upfront tax deductibility of Traditional IRAs with the tax-free withdrawals of Roth IRAs, along with their non-taxable investment earnings for good measure. That’s a triple tax benefit.

There are caveats, of course. HSAs are intended to cover healthcare-related expenses, not retirement spending, hence the name. This has a few implications, and we’ll start with the bad news: only healthcare outlays qualify for the triple tax benefit. Using these funds for non-healthcare expenses prior to age 65 will result in a 20% penalty, in addition to ordinary income taxes. There are no penalties, however, for non-healthcare-related spending after age 65. Those expenses are simply taxed as regular income, just like Traditional IRA withdrawals. That’s not exactly a severe worst-case scenario. And unlike IRAs and 401(k)s, savers don’t need to delay withdrawals until they’re 59½ years old. HSAs are not retirement accounts, after all.

HSAs are not specifically designed to address retirement needs, but their dedicated focus on healthcare spending means they overlap with a big portion of retirees’ expenses. Out-of-pocket healthcare spending averaged about $5,500 per year for Medicare beneficiaries in 2013, and is projected to grow more expensive over the coming decade, according to a report by the Kaiser Family Foundation from earlier this year. A 2018 Fidelity study found that total healthcare spending in retirement can total $280,000 per couple.

We’ve explored the benefits and limitations of HSAs in an effort to help you decide whether they could serve a role in your long-term financial plans.

Contribution Limits | Annual HSA contributions max out at $3,450 per individual and $6,900 per family—relatively low compared to retirement account contribution limits. They offer catch-up contributions of an additional $1,000 per year starting at 55 years old. Some employers offer HSA plans with matching contribution benefits, which creates the potential to increase your total contribution.

Qualifying Expenses | Every standard healthcare expense from medical exams to dental visits is covered under HSA spending. Costs associated with vision (including eyeglasses) and hearing (including hearing aids) also qualify, as will lab tests and prescription drugs. Hospital stays, non-cosmetic operations and therapy are also covered. Traditional health insurance premiums are not eligible for HSA payments.

Nursing and long-term care expenses qualify; in fact, policy premiums for long-term care insurance can also be paid with HSA account proceeds, although the amount that can be paid with tax-free withdrawals increases with age. Long-term care can become a very large financial burden in retirement, so it’s worth considering how an HSA can help manage this risk.

Eligibility | HSAs were created to combat rising healthcare costs; as such, you must be enrolled in a high deductible health plan to make HSA contributions. These plans require enrollees to cover 100% of a pre-fixed amount of healthcare costs out of pocket before their insurance kicks in. This is an expensive proposition, which is why HSA contribution eligibility is limited to this group. You also can’t be enrolled in a flexible spending account (FSA), which share some features with HSAs. Medicare and Veteran’s Administration enrollees are also barred from making HSA contributions.

The eligibility window may be narrow, but it only applies to contributions. Retirees receiving Medicare are still allowed to make qualifying HSA withdrawals, even if they’re no longer enrolled in a high deductible health plan.

HSAs are not just another good place to save for the future. They offer unparalleled tax-friendliness. Their ability to function identically to a Traditional IRA for non-healthcare-related withdrawals—on the unlikely chance that retirees aren’t faced with many medical costs—means they don’t really have any major drawbacks. They really should be considered if you qualify and want to maximize your return on savings.

If you still have questions or concerns regarding this topic, reach out to our retirement plan team experts—we would be happy to help.

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