According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2021 may need approximately $300,000 saved (after tax) to cover health care expenses in retirement. This is a significant amount to plan for in retirement. Thankfully, our tax code allows us to contribute to one of my favorite account types: The Health Savings Account (HSA). The HSA offers triple tax benefits: tax deductible going in, tax deferred while in the account, and tax free if funds are used for qualified medical expenses. Here are a few strategies to think about when evaluating your use of the HSA:
Consider delaying using your HSA funds until retirement: As I mentioned previously, health care costs in retirement are enormous (just to repeat, that’s $300,000!). The most common way to get to that number is through savings and deferred growth. Deferred being the key word. You might be tempted to use your HSA prior to retirement in your early working years to cover an out of pocket medical expense. Consider using your emergency fund first. The expense itself could be tax deductible if you itemize. Deferring usage of your HSA funds as long as possible allows you to capture all three of the tax benefits an HSA offers.
Consider a one-Time IRA transfer: An HSA allows you to move money via a qualified transfer from your IRA into your HSA one time in your lifetime. Why should you do this? Account location. Diversifying how your money is treated in relation to the IRS tax code could pay dividends down the road. Especially if you need a vehicle to pay for that $300,000 with tax free money!
Don’t worry (as much) about overfunding: A common question I receive: “What happens if I put too much in my HSA and come retirement time, I have no (or little) medical expenses?” Well, if your retirement years end up having minimal health care expenses in retirement, do not worry! An HSA is taxed WITHOUT penalty as ordinary income for folks over age 65 (similar to an IRA, except the general age for an IRA is age 59.5). Pulling the money out before age 65 and you’re not using the funds for medical reasons? A 20% penalty DOES apply, unfortunately.
High income earner? Consider a HDHP : When you’re in a higher income bracket, maxing out all of your tax deferred options is usually priority. The only way you can defer into an HSA is through a high deductible plan. Too often I see folks in a high tax bracket elect for the ‘big premium, low out of pocket cost’ plans simply because “I don’t want to be nickel and dimed through out of pocket costs”. I understand the thinking and that does make sense if you’re indeed using hospital services frequently, but if you’re not using hospital services frequently, you’re missing out on tax deferred savings, growth, and tax-free money. You should consider the HSA eligible plan and supplement your smaller premiums with HSA contributions.
Delaying Reimbursements: If you have medical expenses earlier in life, you are able to reimburse yourself through your HSA in later years. For example, let’s say you’re 42 years old and you have an out of pocket health expense of $2,000. Instead of reimbursing yourself in the current year via the HSA, you can wait and defer the reimbursement until later years. The advantage of doing this is growth. Your unused and deferred HSA funds are invested and growing (hopefully beating inflation!). If you’re in a high income bracket later in life, you now have the option of reimbursing yourself with tax free money!
Be mindful of asset location: You have control over where you locate your assets. Just like a globally diversified investment portfolio, you can diversify the taxability of your money. This gives you more flexibility when it’s time to pay taxes. The only way to do this is through efficient and timely planning.
If you haven’t already, the best time to start a plan is today!