According to a Fidelity Retiree Health Care Cost survey, the average retiree age 65 and up will need $295,000 (after tax) to cover the cost of health care expenses while in retirement. And this doesn’t even include Long Term Care costs while living in a nursing facility or requiring assisted living. This is why in our financial plans at Wiser Wealth Management, we run desired living expenses at retirement increasing by 2.25% (to keep track with inflation) and then we also plan for increased healthcare costs by 5%. Last week, I wrote a blog post on Medicare Enrollment dates and I figured that this week I would address ways to help combat these increasing healthcare costs by explaining Health Savings Accounts (HSA) and how they can complement a sound financial plan.
The HSA is often an overlooked and underutilized savings vehicle. It is a tax-advantaged savings account created for individuals and families who have high deductible health insurance plans. For 2020, in order to be HSA eligible, your healthcare plan must have at least a $1,400 deductible for individuals and at least $2,800 for families. There is also a maximum out of pocket limit of $6,900 for individuals and $13,800 for family plans. Insurance premiums don’t count as out of pocket costs, but deductibles, copayments and coinsurance do. The HSA contribution limit for 2020 is $3,550 for an individual and $7,100 for families and will go up to $3,600 and $7,200 in 2021. Individuals over age 55 can make annual catch up contributions of an additional $1,000.
Also, the HSA is one of the few vehicles that offers triple taxation benefits. Like a 401(k) or IRA, the contribution is made pre-tax so that it can help lower taxable income for the year and is 100% tax deductible. The funds saved in the account grow tax free, and unlike a retirement account, as long as the withdrawals are for qualified medical expenses, not covered by an HDHP, they are not taxed. Common qualified expenses include deductibles, dental services, vision care and prescription drugs. If not used for qualified expenses, the amount withdrawn is not only subject to income tax but also a 20% penalty. A notable caveat, however, is that individuals over 65 can avoid this penalty by using the money as a supplement to retirement accounts and only pay income taxes on the distributions.
Unlike a Flexible Savings Account (FSA), often provided through work as well, the funds do not have to have to be used and can be carried over for future expenses. An HSA is portable. If you leave your company, your savings go with you. Or if you pass away, your surviving spouse can receive the account tax free. The most popular HSA custodian companies include: Fidelity, HSA Bank, Optum, Bank of America, Healthsavings, Health equity and Lively. Once accounts pass over the $1,000 threshold (or even a couple thousand for some companies), the HSA allows contributions to be invested into the stock market through various mutual funds and ETFs. Also, HSA participants are allowed a one-time tax free and penalty free rollover from an IRA to an HSA called a qualified HSA funding distribution (QHFD). In order to maintain proper tax qualifications, the individual must be currently eligible for an HSA and must also remain eligible for the plan 13 months following the transfer. The maximum that can be rolled into the HSA is the same as the annual HSA contribution limit for the year.
Another often overlooked strategy of the HSA is what is known as the “shoeboxing” approach. This is where the individual saves the receipts for healthcare transactions and stores them somewhere either in a shoe box or online vault. Although you pay for medical expenses out of pocket, you’re allowing the invested funds within the HSA to grow tax deferred. Currently, there is no timeline on reimbursements, so when you’re ready, you submit reimbursement paperwork for past qualified expenses and then receive tax free repayment.
With the increase in costs of healthcare and the longevity of retirees, it is important to plan appropriately. Just like retirees need their 401k, 403b, 457, IRAs and ROTH IRAs in order to provide peace of mind for a successful retirement, they should also take advantage of future healthcare planning through HSAs.
Matthews Barnett, CFP®,ChFC®,CLU®
Financial Planning Specialist