Could a Health Savings Account Help Strengthen Your Retirement Plan?

Health care expenses are rising faster than inflation, and even insured workers are finding it harder to pay their premiums, copays, coinsurance, and deductibles from year to year—much less plan for the future. The stakes are even higher for early retirees (younger than 65) and self-employed individuals, who must purchase their own health insurance and bear the entire cost themselves.

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According to Fidelity Institutional, a 65-year-old couple who retired in 2020 may need about $295,000 in savings to pay for their health care expenses in retirement. This includes premiums for Medicare Part B and Part D, supplemental (Medigap) insurance, and median out-of-pocket prescription drug expenses, but not other health expenses, such as long-term, dental, and eye care.

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What can you do to alleviate some of this growing cost? It may be in your best interest to consider a health savings account (HSA). An HSA is a tax-advantaged account linked with a high-deductible health plan (HDHP). They work together to help you cover your current health care costs and save for your future needs.

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The Tax Benefit Trifecta

HSAs offer several tax benefits to encourage diligent saving:

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• Pre-tax contributions can often be made through an employer via a payroll deduction, or you can make contributions yourself and take a tax deduction, whether you itemize or not. Either way, HSA contributions reduce your adjusted gross income and federal income tax for the current year.
• Any interest or investment earnings compound on a tax-deferred basis within the HSA.
• Withdrawals are tax free if the money is spent on qualified medical expenses. When HSA money is spent on anything other than qualified medical expenses, withdrawals are taxed as ordinary income, and a 20 percent penalty applies to taxpayers younger than 65. Depending on your state, HSA contributions and earnings may be subject to state taxes.

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HSA Contribution Rules

The maximum HSA contribution limit in 2021 is $3,600 for individual coverage or $7,200 for family coverage. This annual limit applies to all contributions, including those made by you, your family members, or your employer. You can contribute an additional $1,000 starting the year you turn 55. Once you sign up for Medicare, you can no longer contribute to an HSA. Funds roll over from year to year and are portable, meaning they are yours to keep. When HSA balances reach a certain threshold, you can steer the funds into a paired account with investment options similar to those offered in a 401(k). You can make contributions up until April 15th of the following year (i.e., you can make 2020 contributions up to April 15, 2021).

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Pros and Cons to Consider

Con: Balancing spending and saving. HSA owners must pay attention to prices, so they can select lower-cost providers and avoid unnecessary spending. On the other hand, some people with HDHPs might be reluctant to seek care when they need it because they don’t want to spend the money in their account.

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Con: High deductibles. A high deductible can make it difficult to pay for a costly medical procedure, especially if there hasn’t been much time to build up an HSA balance. To be eligible to establish or contribute to an HSA, you must be enrolled in a qualifying HDHP with a deductible of at least $1,400 for individuals, or $2,800 for families, in 2021. Workers who are offered HDHPs (as a choice or their only option) or purchase their own insurance often face much higher deductibles. According to the Kaiser Family Foundation, the average deductible for employer-provided HDHPs in 2020 was $2,303 for individual coverage and $4,552 for family coverage.

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Pro: Out-of-pocket maximums: Qualifying HDHPs also have out-of-pocket maximums, above which the insurer pays all costs. In 2021, the upper limit is $7,000 for individual coverage or $14,000 for family coverage, but plans may have lower caps. This feature could help you budget accordingly for a worst-case scenario. Premiums are typically lower for HDHPs than traditional health plans. Until the deductible is satisfied, members usually pay more up front for services such as physician visits, surgery, and prescriptions, but they typically receive the insurer’s negotiated discounts. Some preventive care, such as routine physicals and cancer screenings, may be covered without being subject to the deductible. Under IRS guidance issued in 2019, the list of preventive care benefits that HDHPs may provide was expanded to include certain medications and treatments for chronic illnesses, such as asthma, diabetes, depression, heart disease, and kidney disease. Providing this coverage encourages patients to seek care before problems become more serious and costly.

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Pro: Flexibility after age 65. Account funds not needed for health care expenses are available for any other purpose after you reach age 65. Although HSA funds cannot be used to pay regular health plan premiums, they can be used for Medicare premiums and qualified long-term care insurance premiums and services that you may need later in life. If you can afford to fund your HSA generously while working, some of those dollars could be left untouched to accumulate for years. You could even pay current medical expenses out of pocket and preserve your HSA assets for use during retirement. But save your receipts in case you have an unexpected cash crunch. You can reimburse yourself for eligible expenses at any time.

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Compare Carefully

Open enrollment is the time of year when employers typically introduce changes to their benefit offerings. If you purchase your own health insurance, you might also be presented with new options for 2021. The bottom line is that choosing and using your health care plan carefully could help you save money. If you go with an HDHP, be sure to contribute the premium dollars you are saving to your HSA—and more if you can. Before you sign up for a specific plan, read the policy information and look closely for any coverage gaps or policy exclusions, consider the extent to which your prescription drugs are covered, estimate your potential out-of-pocket costs based on last year’s usage, and check whether your doctors are in the insurer’s network.

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This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.