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Using a Health Savings Account For Retirement

by | Feb 13, 2019 | Retirement

Have you ever had to take care of an elderly parent or grandparent? If so, you know it’s not an easy thing to do. Having an elderly relative live with you can put a strain on your family. Particularly if you’re raising kids at the same time. But a nursing home can be prohibitively expensive, especially if the relative doesn’t have the financial means to pay for that care.

The cost of caring for a loved one increases as they age. You may find yourself faced with a difficult choice between cost and quality of care if your loved one isn’t prepared to deal with those costs. No one wants to face that choice.

So how can you prepare yourself so that your own children don’t have to face that unenviable choice? One “tool” in the retirement toolbox that you may not have considered is using a Health Savings Account (HSA). In this post, I’ll teach you about the potential of using an HSA for your future medical expense needs.

Brief History and Overview of HSAs

Health Savings Accounts have been around since 2003. One of the big reasons why HSAs were created was to help control healthcare costs. How?

Think about this scenario. When the insurance company pays the full cost of your doctor visit, do you really know how much that visit cost? Probably not. But, if you’re paying for the doctor visit out of your own pocket, it becomes very clear how much that visit cost you!

HSAs incentivize new behaviors. The government gives you a tax break on money you contribute to the HSA (incentive). The trade-off is that you have to pay for more of your medical expenses with the cash you stash away. Since you’re paying in cash, the idea is that you’ll be more careful with your medical spending, lowering healthcare costs.

Here’s a simple example based on someone in the 22% tax bracket.

In this example, the HSA contribution gave the saver $3,000 of medical expense “buying power” but she only had to take $2,340 out of her pocket to get it. The reason for this is she got a tax break when she put money in the HSA.

Sounds great, right? Everyone should use an HSA. But there’s one important catch.

HSAs can only be opened by people who have what’s called a “high deductible health plan.” HDHP for short. These plans have high deductibles, which means you need to pay more medical costs out of your own pocket before insurance kicks in.

If you have a good healthcare plan at work it’s likely you won’t be able to contribute to an HSA. Many company plans are not HDHP plans.

Still, you should understand the power of HSAs in case your circumstances change.

The HSA Triple-Tax Advantage

The unique feature with HSAs that they enjoy a “Triple-tax advantage.” What this means is:

  • You get a tax deduction for money you put into an HSA
  • The money you earn by saving and investing your HSA money grows tax-free
  • You don’t pay taxes when you take money out of your HSA as long as they’re for qualified medical expenses.

This last point is important. If you take money out of your HSA to pay medical bills (what the IRS calls ‘qualified medical expenses‘) then you won’t be taxed on money you take out. BUT, if you take the money out and spend it on non-medical expenses, you’ll be taxed on everything AND pay a 20% penalty! (There’s no penalty if you’re Age 65 or over.)

No other account – not Traditional IRAs, Roth IRAs, or 401(k)s, – offer this kind of “triple-tax” advantage. With those other accounts, Uncle Sam is always going to get his cut through taxes. Not so with HSAs, assuming you take money out for medical expenses…tax-free in and tax-free out. As we say in Wisconsin, “It don’t get no better!”

Other Advantages of HSAs

There are three other nice features to HSAs that make them useful as a retirement savings vehicle.

First, your HSA money can be rolled over from year-to-year. There’s no rule that says you have to “spend” your HSA savings each year. So if you put $3,000 into your HSA, you can leave it there as long as you wish.

Secondly, there’s no “expiration date” for claiming past medical expenses. Here’s an example. You have a $1,000 medical expense in 2019 that you decide to pay out of your own pocket. 10 years from now you decide you’d like to get that money back by taking $1,000 out of your HSA. You can do that! The issue here is that you’ll have to be a very good recordkeeper. The IRS will want to see that $1,000 receipt from 2019. But the ability to claim past medical expenses gives you a lot of flexibility with your HSA.

Finally – and more importantly – you can invest your HSA savings in the stock and bond markets. Doing so gives you the opportunity to grow your money over the course of many years. This is the “secret sauce” that makes HSAs a great retirement vehicle.

Depending on your HSA plan, it might take a little work to get your HSA savings into the right kind of account. Many HSA plans are sponsored by banks, which stick your HSA money into a savings account earning paltry interest rates. But you can usually put this money in an account that allows you to invest for growth.

How to Use HSAs for Retirement

When you save for retirement, you’re investing money today that you’ll use when you retire. You’ll use this money in a variety of ways when you retire. Visualize two buckets for your retirement spending needs: Living Expenses and Healthcare Expenses. These two “buckets” of expenses have very different characteristics.

Living expenses are largely in your control. You choose what kind of home you want to live in and how much you want to spend on it. You choose how much you eat, how often you travel, and how much you spend on clothes. These expenses are controllable.

Healthcare expenses, on the other hand, are often outside of your control. You can’t control if/when you get sick. You can’t control whether it’ll cost a little or a lot to treat your illnesses. And you can’t control if you’ll need special care, like a nursing home or memory care. You’re at the mercy of how well you age…or don’t.

By separating retirement savings into these two buckets, you can see how HSAs fit into a retirement plan.

Hypothetical Retirement Savings Plan Using an HSA

To help illustrate the value of using an HSA for retirement, I want to look at a very simple example.

Assume you’ve worked with your financial advisor and she has determined that you need $1.2 million saved up by the time you retire at Age 65. As she did the work, she determined that $1.0 million of these savings would be for Living Expenses. The other $200,000 would be for Healthcare Expenses while you’re retired. Your tax rate in retirement would be 22%.

If you only saved in a Traditional IRA or 401(k), you’d have to have to have $1,538,462 in your account on the day you retired. Remember, on a Traditional IRA or 401(k), you get a tax benefit when you put money in the account. Uncle Sam gets his cut on the way out.

What if you used an HSA for your estimated $200,000 of Healthcare Expenses and a Traditional IRA or 401(k) for the other $1.0 million? Let’s look:

Notice what’s happening here. You end up with the same $1,200,000 to spend in retirement. But by using an HSA for your healthcare expenses, you save big money on taxes when you take money out of your HSA account.

Conclusions About HSAs

Health Savings Accounts can be an important tool in your retirement savings arsenal. The ability to take money out tax-free to pay for medical expenses can save you a ton of money in retirement.

Success depends on having a good idea of what your healthcare costs will be in retirement. That’s not an easy task. But next week, I’m going to talk about key issues you should be thinking about regarding your future healthcare costs.

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