You may not realize this, but a health savings account (HSA) can be used as a retirement vehicle. If you’ve maxed out your 401(k) and IRA contributions, maxing out an HSA could be another source of retirement funds.
A health savings account offers triple tax savings because you contribute pre-tax dollars, pay no taxes on earnings, and withdraw the money tax-free now or in retirement to pay for qualified medical expenses.
Given the vast majority of us will incur qualified medical expenses as we age, contributing to an HSA to address these expenses is a good idea.
You can use your HSA to pay for eligible health care, dental, and vision expenses for yourself, your spouse, or eligible dependents (children, siblings, parents, and others who are considered an exemption under Section 152 of the tax code). Qualified medical expenses encompass almost everything you can think of as well.
You can even use the money for nonmedical expenses after age 65, such as buying a Lamborghini. However, be aware this expense will be adjudicated as nonmedical and taxed as ordinary income. Further, be aware if you are under age 65, there is a 20% penalty on nonmedical withdrawals in addition to the tax.
Invest As Tax-Efficiently As Possible
The more money we can invest in a tax-efficient manner to pay for upcoming expenses, the more money we will likely end up having. After all, taxes will likely be our largest ongoing liability.
For retirement expenses, we invest in retirement vehicles like the 401(k), 403(b), Solo 401(k), Roth IRA, IRA, and SEP IRA. For our children’s education expenses, we invest in a 529 plan. Therefore, investing in an HSA for medical expenses is also a rational decision.
The thing is, not everyone is eligible for a health savings account.
How To Be Eligible For A Health Savings Account
In order to be eligible for a health savings account, you need a high deductible health plan (HDHP). The HDHP from work or in the private marketplace must have a deductible of at least $1,350 for individuals and $2,700 for family coverage.
The people who usually get a high deductible health plan are those who want to save money on monthly health insurance premiums. For those of you who are younger, healthier, and don’t expect to need medical services, getting an HDHP may be a good way to save.
By using money from your health savings account, you’ll be able to cover the cost of your deductible in a tax-efficient manner, if these costs and more were to arise.
For those of you who are older, less healthy, and have many dependents, getting a high deductible health plan to qualify for a health savings account may not be the optimal move. Your chances of paying for your entire high deductible and more are higher. Further, you may face healthcare service limitations such as not being able to get the quality or type of care you need in extenuating circumstances.
Maximum Contribution Limit To A HSA
For single people, the HSA contribution limit will increase from $3,600 in 2021 to $3,650 in 2022. Family coverage is always double the single coverage. Therefore, the HSA contribution limit for families will increase from $7,200 to $7,300. For those 55 and up, there is a catch-up contribution of $1,000 more per year. Hence, a family can contribute $8,300 to an HSA in 2022.
Using an HSA as a retirement vehicle works if you can accumulate a lot of money in your HSA while still working. The only way to do that is to contribute the maximum each year, invest it wisely, and then use as little of the HSA money as possible.
To preserve your HSA balance, you could pay for any qualified medical expenses with non-HSA money. However, it’s generally better to use your HSA money when you are paying a higher marginal income tax rate.
HSA For Retirement Healthcare Expenses
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. Some estimates are for more than $400,000.
If you use a 6% compound growth percentage, $300,000 will turn into $537,000 in 10 years and $962,000 in 20 years. Therefore, it’s good to do what you can to save for retirement healthcare expenses. I have no doubt healthcare costs will continue to rise by at least 5% a year, forever.
Due to my belief that healthcare companies will continue to profit handsomely off us, one of my hedges is to invest in my healthcare provider, such as UnitedHealth Group (UNH). You may want to consider doing the same.
In America, there really is no beating the rising cost of healthcare. As a nation, we are gradually getting less healthy. Only if we suddenly had to move our bodies for a living and if food companies are no longer allowed to produce sugary processed foods, maybe we’d have a chance.
A $1 Million HSA Balance Is Possible
One of the reasons why I didn’t invest in a Roth IRA while I was younger was because the contribution limit was so low. Not investing in a Roth IRA is one of my regrets today.
You might feel HSA contribution limits are too low to bother having one as well. However, a $3,650 tax-free contribution limit per year per person in 2022 is nothing to sneeze home and get sick about.
Below is a chart that shows a family contributing the maximum annual HSA over a 30-year period. Remember, a family can now contribute a maximum of $7,300 a year. If the family never touches the HSA, and the balance grows by an average of 8.6% a year for 30 years, the balance will grow to $1 million.
The HSA cash balance of $322,000 assumes a 2.4% annual rate of return, which is unlikely due to our current low interest rate environment. But even with 0% growth, 30 years of contributing $7,300 a year equals $219,000 tax-free.
If you have to pay a 20% long-term capital gains tax in retirement, then $1 million in an HSA equals $1,250,000 in pre-tax gains. In other words, you don’t need to save as much for medical expenses with an HSA.
How An HSA Works For Estate Planning
There is also a possibility you could pass on your HSA to your heirs. This situation may arise if your medical expenses are much lower or you die younger than expected. There is also no required minimum distribution for HSAs.
In such a scenario, three things can happen:
1) Your spouse inherits the HSA after your death with the same triple-tax-free treatment.
2) Someone else other than your spouse inherits your HSA because you’re single or don’t like your spouse. In such a scenario, the fair market value of the HSA becomes taxable to the beneficiary in the year in which you die.
3) Finally, your estate is the beneficiary. The fair market value of the HSA is included on your final income tax return.
Ideally, you die before your spouse and s/he inherits your HSA. This way, your spouse won’t have any tax consequences. Further, outliving your spouse creates a lot more heartache.
If you don’t have a spouse and want to save on taxes, name your estate or beneficiary, whichever party is in the lowest tax bracket. Of course, you ultimately want to name a beneficiary you care about the most.
Please consult an estate planning lawyer for more clarification and details. If you haven’t set up a revocable living trust, a will, and/or a death file, please do so ASAP. I promise you will feel so much relief once you do.
Wealthier People Don’t Have HSAs
Although I just got done discussing the benefits of a health savings account as a retirement vehicle, perhaps getting an HSA isn’t the best move.
There is not one rich person I know ($10+ million net worth) who has an HSA. The reason why is because no rich person I know is willing to get a high deductible health plan.
Instead of having an HDHP, rich people either get Platinum plans with low deductibles or Medical Concierge Service on top of their Platinum plans. Their main concern is having the highest quality care and access possible. When it comes to health, rich people are less willing to gamble for the sake of saving money.
There is a fear by rich people that an HDHP will be too limiting when healthcare is needed the most. There are too many horror stories of denial of service or outrageous costs in the healthcare world. The hope is that by having a better plan, these issues will decrease.
When we are sick, we often are willing to spend a lot more money to get treated or at least get answers.
Medical Concierge Service
For an extra annual fee, you can get Medical Concierge Service where your primary care provider will give you special access. This is the exact opposite of getting a HDHP.
You may get the doctor’s private number and e-mail to contact whenever you have an issue. Fitting in last-minute appointments is usually much easier. Further, your doctor might even conduct house visits, which may be especially attractive during a pandemic.
Going to a doctor’s office when people are more likely to be sick is already a concern. Catching something in the hospital is one of the reasons why doctors encourage new mothers and newborns to go home as soon as they are healthy enough to do so.
When people were frantically trying to get a vaccination appointment during the first round, a family with Medical Concierge Service might have been able to get an appointment with ease.
For an extra $5,000 a year, my primary care doctor offers Medical Concierge Service. His selling point is access and a comprehensive physical. If he’s still practicing in 10 years, I might take him up on it. I know other Medical Concierge Services that cost an extra $25,000 – $75,000 a year.
Requires Discipline To Use An HSA As A Retirement Vehicle
In theory, having an HSA to help fund your medical costs in retirement makes a lot of sense. It’s just like how renters against homeownership like to say they will save and invest the difference. However, the data shows the vast majority do not.
In practice, it may be more difficult than you think to grow your HSA balance because you can’t control a lot of future medical issues. Further, you have to stay disciplined in contributing to an HSA and investing it over the long term. Sometimes, the more money you have, the more you are tempted to spend it on whatever.
If you want to diversify your financial sources in retirement, an HSA is a worthwhile investment vehicle. However, by all means, use your HSA for qualified medical expenses when they arise.
When you’re working, you will likely be in a higher tax bracket than when you are retired. Therefore, it actually makes more sense to utilize your HSA before retirement if medical issues pop up.
With two young children with as yet unknown health issues, my family won’t be getting a HDHP to qualify for an HSA. Maybe once our kids turn 15 and all the health issues are known, an HDHP may be more appropriate.
However, by then my wife and I will also be in our 50s and less healthy. We should also be wealthier. Therefore, getting an HSA is likely not in our future. Instead, we will probably continue to boost our taxable investments in order to increase our passive investment income.
Recommendation And Reader Questions
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Readers, are any of you planning on using a Health Savings Account as a retirement vehicle? How big has your HSA gotten? Have there been any hiccups along the way in building up a large HSA?
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