In previous postings, we have mentioned Health Savings Accounts (HSAs) as tax-favored plans that can help with planning for medical costs. But there are some other important angles to HSAs that ought to be considered by qualified individuals in terms of giving retirement income a tax-advantaged shot in the arm.
First, a few basics … HSAs were created by Congress in 2003 as a means of giving certain people additional control over how their healthcare dollars are spent. However, the only people who can contribute to an HSA are those who are covered by a high-deductible health plan (HDHP). These plans, as the name implies feature very high deductibles—typically a thousand dollars or more—that must be met before the plan pays anything. Basically someone covered by an HDHP pays most of their expenses out-of-pocket, unless they encounter some sort of catastrophic health situation or accident. The tradeoff, of course, is a low premium for the coverage. Especially for the young who are in good health, HDHPs can be advantageous, due to the lower premiums.
The HSA fits into the picture this way: when someone covered under a high-deductible plan contributes to an HSA, the money in the plan is contributed on a tax-deductible basis and, if it is invested, grows tax-free as long as it is in the plan Maximum annual contribution varies by type of HDHP coverage, but can range from $3,400 for persons covered on an individual plan to $6,750 for a covered family. After age 55, qualified individuals can make an additional $1,000 annual “catch-up” contribution to their plans. Furthermore, withdrawals from the plan used to pay qualified medical expenses incur no penalty and are not taxed as income. Unlike the cafeteria plans offered by many employers, funds in an HSA can be rolled over from year to year, if they are not used to pay medical expenses—all the way to retirement, theoretically.
Here’s where it starts to get really interesting. After age 65, money may be taken from the plan for any purpose—medical or otherwise—with no penalty. It will, however, be taxed as ordinary income, in most cases, just like withdrawals from an IRA or 401K.
And there is one other wrinkle that can make withdrawals in retirement even sweeter—but only for those who are organized and patient. The owner of an HSA can actually take withdrawals from the plan to reimburse him- or herself for medical expenses that were incurred in previous years, as long as those expenses were not paid by insurance or an employer. So, if you paid the medical expenses out-of-pocket and you saved your receipts and other documentation, you could reimburse yourself in retirement for those expenses—and you would not even pay tax on the reimbursement.
So, in summary … With an HSA, you can make tax-deductible contributions now, enjoy tax-sheltered growth until retirement, and, potentially, get tax-free reimbursements in retirement. More information on HSAs is available in IRS Publication 969, or you can also talk to your financial advisor to find out if you qualify and to decide if an HSA is right for you.
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