Planning for healthcare expenses in retirement is crucial, especially considering that Medicare doesn't cover everything and healthcare costs tend to rise over time. Health Savings Accounts (HSAs) were specifically designed to help individuals save for healthcare expenses in retirement, and now, due to inflation, they have become even more advantageous.
HSAs have always been an exceptional tool for building a growing pool of funds to cover future medical costs. Since the annual contribution limits are tied to inflation, the increase in the 2023 limits has been significant, approximately 5.5% higher than the previous year's limits.
Triple Tax Advantage
These accounts offer a "triple-tax-advantaged" approach to savings:
Contributions are made with pre-tax dollars, reducing your taxable income in the year.
Account growth is tax-free.
Qualified withdrawals for medical expenses are tax-free as well.
Understanding Health Savings Accounts
HSAs are special savings or investment accounts that allow individuals to set aside money before taxes to be used for qualified medical expenses. These expenses encompass deductibles, copayments, coinsurance, long-term care, and various healthcare costs. To contribute to an HSA, individuals must pair it with a high deductible health plan (HDHP), which typically offers lower monthly premiums in exchange for a higher annual deductible.
Benefits of HSAs
Saving in an HSA offers benefits both in the present and during retirement. Contributions can often be made through workplace payroll deductions with pre-tax dollars, and funding an HSA with after-tax dollars allows you to claim a tax deduction. By refraining from using your HSA for current medical costs and letting it grow, you have the potential to maximize the power of compounding. Withdrawals from the account in retirement for qualified medical expenses are not taxed as income, unlike other tax-advantaged accounts. Furthermore, changing jobs or health insurance providers does not affect your HSA since it remains your account.
The funds in an HSA never expire and can even be incorporated into your estate plan.
Contribution Limits and Working
Contribution limits are tied to inflation, resulting in a significant increase for 2023. For individuals with self-only insurance coverage and an HDHP, the contribution limit is up to $3,850, while family coverage allows contributions of up to $7,750. Individuals aged 55 and above can also make an additional catch-up contribution of $1,000.
How They Work
The list of qualified medical expenses covered by HSAs is extensive, including acupuncture, doctor visits, psychological therapy, hearing aids, prescription drugs, and more. Keeping receipts is necessary, but many HSA accounts offer convenient online access and even provide debit cards for easy transactions. If you opt for an investment account, you'll have various investment options to choose from, though it's essential to consider associated fees and seek out lower-cost alternatives.)
Limitations and Penalties
Similar to other tax-advantaged accounts, failure to comply with the rules may result in tax penalties. Withdrawing funds from an HSA before age 65 for non-medical or unqualified medical expenses will subject you to federal income tax on the amount, along with a 20% tax penalty. However, if you're 65 or over and withdraw funds for non-medical or unqualified medical expenses, you will still pay federal income tax on the amount but avoid the 20% tax penalty.
Health Savings Accounts and Equity Compensation
Individuals with equity compensation can particularly benefit from leveraging HSAs as part of their financial strategy. By maximizing contributions to an HSA, individuals can take advantage of the tax advantages and potential growth of these accounts. Additionally, HSAs offer flexibility and portability, allowing individuals to maintain control over their funds even if they change jobs or health insurance providers.
Furthermore, by combining the power of HSAs with equity compensation plans, individuals can enhance their financial well-being and build wealth over time. As equity compensation can provide a significant boost to overall wealth accumulation, allocating a portion of these earnings to an HSA can help cover future healthcare expenses in retirement.
The Bottom Line: HSA Can Be A Valuable Tool
Health Savings Accounts offer a powerful means of saving and investing for one of the most significant retirement expenses – healthcare costs. Given the substantial contribution limits, it may be wise to consider opening an HSA or increasing contributions to an existing account, empowering you to secure a healthier financial future.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
This content not reviewed by FINRA
