The secret is out on health savings accounts (HSA), and people of all ages are starting to embrace them as a way to pay for healthcare expenses.
At last check, there was more than $100 billion saved in more than 33 million HSA accounts. And by the end of this year, HSA funds are expected to exceed $150 billion.1
HSAs are a way to pay for healthcare costs with pre-tax dollars. HSAs are considered triple tax advantages because you 1) contribute pre-tax dollars, 2) pay no tax on earnings, and 3) can withdraw the money tax-free (in most cases) to pay for qualified medical expenses.
Backgrounds of HSAs
In 2003, congress passed the Medicare Prescription Drug, Improvement, and Modernization Act, which created HSAs. Previously, medical savings accounts were available but only lightly used because they were restricted to Medicare enrollees. Unlike popular flexible spending accounts, HSA funds roll over and accumulate year-to-year if they are not spent.2
HSAs are structured to be used with high-deductible health plans (HDHP). When you select an HSA as part of your company’s benefits, contributions are made with pretax dollars. Once your HSA account reaches a certain balance, funds can be invested according to the guidelines set up by your HSA administrator.
If you spend your HSA funds on non-qualified expenses before age 65, ordinary income taxes may apply, and it may result in a 20% penalty. After age 65, you may be required to pay ordinary income tax if the funds are used for non-qualified expenses. Contributions are exempt from federal income tax but in some cases are not exempt from state tax.
HSAs in Retirement
There are two key points to understand about HSAs after age 65.
First, you cannot set up or contribute to an HSA after you are enrolled in Medicare. Second, to avoid any potential tax penalties, you should consider stopping contributions to an HSA about six months before you apply for Social Security.
What Can an HSA Pay For?
If you have money in an HSA, the funds can be used to pay for a wide range of qualified medical expenses in retirement, such as deductibles, copayments, and coinsurance. Here are some ideas about what is possible.3
1. Pay for Medicare premiums:
Your HSA account can pay certain Medicare expenses, including premiums for Part B and Part D prescription drug coverage. Your HSA cannot be used to pay for supplemental (Medigap) premiums.
2. Extended-care expenses:
Your HSA can be used to pay for part of an extended care policy, but some restrictions apply.
3. Other expenses:
Once you reach 65, you can use your HSA account to pay for anything but be prepared to pay ordinary income tax on any distributions not used for health care.
4. Estate strategies:
If you have money in your HSA, you can pass it along to your heirs. But keep in mind there is one set of rules for your spouse and another set of rules for others.
5. No required minimum distributions (RMDs):
Unlike other retirement accounts, no RMDs are necessary from an HSA.
An HSA is a flexible tool that can play a variety of roles in retirement. If you’re considering starting one, or have one already opened, let’s talk about your strategy for making contributions knowing there are certain limits.