Your HSA – A Powerful Retirement Savings Vehicle?

I was recently having dinner with a friend and the topic of Health Savings Accounts (HSA) came up.  Yes, I know you are all jealous about the engaging conversations I seem to be having with my friends!

Our conversation centered around the fact that he recently accepted a position with a new employer and will now be eligible to contribute into an HSA.  He wasn’t sure whether this was an efficient use of his money and had questions on how they work. I explained that an HSA can be one of the most powerful retirement savings vehicles due to the tax advantages that are available.

In order to make the most of these accounts, it is important that individuals understand how an HSA can fit into their retirement planning. This article will explain what a Health Savings Account is, who qualifies, common pitfalls and how to use it for retirement in the most tax advantaged way.

What is a Health Savings Account?

A Health Savings Account (HSA) is an account that you open with a bank, insurance company, or other approved financial institution to help pay or reimburse certain medical expenses you incur.  The contributions into the account can be completed through payroll deduction or as a lump sum.  In addition, some employers offer an annual contribution into your HSA as an employer benefit.

What are the benefits of a Health Savings Account?

The following benefits were taken directly from IRS Publication 969:

• You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions on Schedule A (Form 1040).

• Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.

• The contributions remain in your account until you use them.

• The interest or other earnings on the assets in the account are tax free.

• Distributions may be tax free if you pay qualified medical expenses.

• An HSA is “portable.” It stays with you if you change employers or leave the work force.

Who qualifies to make Health Savings Account contributions?

In order to make contributions into an HSA, you must first meet the following requirements:

• You are covered under a high deductible health plan (HDHP) on the first day of the month.

  • (See the common pitfalls section for more detail)

• You have no other health coverage. It is still possible to qualify for an HSA even if your spouse has a non-HDHP as long as you aren’t covered under that plan.

• You aren’t enrolled in Medicare.

  • (See the common pitfalls section for more detail)

• You can’t be claimed as a dependent on someone else’s tax return.

If I qualify, what are the annual contribution limits?

In 2019, single individuals can contribute $3,500 annually into an HSA if they meet the requirements listed above.  For a family, the contribution limit is $7,000 annually.

If you are 55 or older by the end of the tax year, you can contribute an additional $1,000 annually into your HSA.  If both spouses are over the age of 55, they can both contribute an additional $1,000 annually pushing the family limit to $9,000 annually.

What are the common pitfalls?

Using your HSA Account for Non-Qualified Medical Expenses

IRS Publication 969 provides a full description of what expenses are considered qualified medical expenses as well as examples regarding expenses which are not considered to be qualified.  One of the most common examples of a non-qualified medical expense is over the counter medication in which a prescription is not needed.  In addition, most medical insurance premiums are not considered a qualified medical expense.  A few exceptions to this rule are long term care insurance premiums, COBRA premiums, health care coverage while receiving unemployment, and Medicare insurance premiums if over age 65.

Separate HSA Accounts vs. Joint Accounts

When both spouses are covered under a qualified HDHP and therefore are eligible to contribute into an HSA, their contributions must be made into separate HSA accounts.  There are no joint HSA accounts.

Assuming Your High Deductible Health Plan is HSA qualified

One of the most common misconceptions is that all high deductible health plans qualify for HSA contributions.  This is not actually the case.  There are both minimum and maximum deductible limits set by the IRS each year to qualify as a HDHP.  However, the simple fact that a plan has met these guidelines does not in itself qualify the plan as HSA eligible.  In fact, most high deductible health plans on the Federal market are not HSA qualified due to an IRS rule which specifies that except for preventative care, HSA qualified plans may not provide benefits until the deductible for that year is met.  Without going into too much detail here, the point is that you should check with your HR department or insurance company to ensure that the plan is HSA qualified prior to enrolling.

Medicare Coverage and HSA’s

One of the lesser known provisions of the IRS rules regarding HSA contributions is the fact that an individual is no longer eligible to make contributions into an HSA once they sign up for Medicare.  This includes Medicare Part A.  I have met multiple individuals who have been instructed by other professionals that they must enroll for Medicare Part A at age 65 even if they currently have group medical coverage through their employer.  If not, they are told that they will pay a penalty for not enrolling on time.  The rules regarding Medicare enrollment are far too complex to cover in this article, but please know that enrolling for Medicare Part A will end your eligibility to make HSA contributions.  Given this information, it may not be in your best interest to enroll in Medicare Part A when still covered by your employer plan.  Please check with your Medicare insurance agent prior to enrolling to ensure that you fully understand your options.

How to use your Health Savings Account if you can’t afford to maximize your contributions each year

For many families, the cost of healthcare has become so great that they are unable to make the maximum contributions into their HSA each year.  For those individuals, it is important to use the HSA to pay qualified medical expenses as they are due.  As an example, if your family receives a medical bill for $500 it doesn’t make sense to pay that directly.  Instead, you will first contribute $500 into your HSA account and then you will pay the medical bill directly from your HSA account.  This provides you a tax deduction on the $500 that was contributed.  If you follow this same procedure each time qualified medical expenses are due up to the annual maximum contributions allowed, you could save a substantial amount of money in federal taxes each year.

Using your Health Savings Account as a powerful retirement savings vehicle

Another strategy exists for those families who can maximize their HSA contributions each year and in addition, can pay for their medical expenses using other funds outside of their HSA.  For these individuals, we can incorporate the HSA into their retirement plans.  As discussed previously, an HSA is tax deductible when you make the contribution, then the growth of the account is tax-deferred, and distributions from the account are tax free if they are used on qualified medical expenses.  So, we get to have our cake and eat it too!  Here is an example to show how this works:

Let’s say that we have a couple who are both age 50.  They are covered by an HSA qualified HDHP and plan to retire at age 65.  If they make the maximum HSA contributions for the next 15 years, excluding any contribution limit increases that the IRS may provide during that time, the couple will have contributed $35,000 in the first 5 years ($7,000 x 5 years) and then an additional $90,000 in the last 10 years ($9,000 x 10 years) for a total of $125,000.  If the monthly contributions into the HSA are invested within the account at a 5% annual rate of return, the HSA account would be worth approx. $181,800 by age 65.  This couple now has $181,800 tax free to use in retirement for Medicare premiums, long term care premiums, and qualified out-of-pocket medical expense.  In addition, unlike a Roth IRA, they never paid taxes on the initial contributions either.

Where do I go for more information on Health Savings Accounts?

As mentioned earlier in the article, IRS publication 969 is a great resource for anyone wanting more in-depth information on Health Savings Accounts.  In addition, feel free to contact me to see whether incorporating a Health Savings Account strategy into your retirement plan is the right option for you.