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Health and Welfare

A Healthy Retirement with a Health Savings Account

What comes to mind when you think about retirement? Golf? Sunny beaches, perhaps? Responsible management of a traditional retirement savings account like a 401(k) can put you in a place to enjoy whatever comes to your mind when you think about retirement. Most employers offer benefit packages that include opportunities to invest in tax-advantaged retirement vehicles, and a large percentage of employees are investing in them nation-wide.
However, one of your most significant retirement expenses is likely something that doesn’t come to mind when you contemplate retirement. US News recently reported that health care is Americans’ second largest retirement expense after housing costs. Out-of-pocket costs for medical, dental, and prescriptions will likely inflate to over 20 percent of a typical retiree’s budget as they age into their 70s and 80s. Fidelity Investments estimates that a couple retiring at age 65 will spend $245,000 on health care throughout their retirement. As much as we’d like to avoid thinking about health care, preparing for those expenses is a vital part of a sound retirement plan.

Fortunately, preparing for the increased cost of health care in retirement is becoming easier. One of the best tools to make it easier is the health savings account (HSA). Like a 401(k), an HSA is a tax-advantaged savings vehicle. However as you’ll see, the tax savings enjoyed by using an HSA to pay for health care expenses are significantly greater than with a traditional retirement plan. Thus, the HSA can be a vital part of your overall retirement strategy. Here’s how:

  1. Open an HSA. An HSA is an individually-owned account, and many banks offer them. In order to be eligible to contribute to an HSA, you must be covered by a qualified high-deductible health plan (HDHP). Many employers who offer a HDHP option also offer easy ways to contribute to your HSA via payroll deduction. Some will even make contributions to your HSA on your behalf.
  2. Contribute Tax-Free. Contributions to an HSA are tax-free up to the IRS’s statutory annual limits, which in 2016 are $3,350 if you’re covered under an individual health plan or $6,750 if you’re covered under a family health plan. If you’re over 55 you can contribute an extra $1,000. That’s up to $7,750 you can save tax-free every year.
  3. Invest Tax-Free. Most HSA options include an interest rate for accumulated funds. Many offer investment options in mutual funds or other investment vehicles. In all cases, the interest earned on your investment is tax-free.
  4. Pay for Medical Expenses Tax-Free. When you retire, the money you have accumulated in your HSA, both from contributions and interest earnings, is available to spend on qualified medical expenses tax-free. Of course, you can spend the money before retirement too.

As outlined above, dollars spent on medical expenses through an HSA are never taxed. This is in contrast to dollars contributed to a traditional retirement plan like a 401(k), which is taxed upon withdrawal, or a Roth, with is taxed before contribution. The unique tax treatment of HSA dollars makes it a powerful retirement planning tool to complement your traditional retirement savings vehicles.

Despite this extremely advantageous tax treatment, HSAs continue to be under-utilized – especially as tools to prepare for retirement. According to the large HSA investment provider Devinir, only about 14% of the money held in HSA accounts is invested. This indicates that HSA funds are largely being used on current medical expenses rather than being saved for retirement.

Perhaps the single largest barrier to HSA growth is the requirement that contributions to an HSA be made only when an individual is covered under a qualified high-deductible health plan. The good news is that more employers are benefiting financially by offering these types of qualified high-deductible health plans because they made sense for them financially. So while under-utilized, invested HSA funds are growing quickly – by over 33% year over year according to Devinir. For employees who have the option to enroll in a qualified high-deductible health plan, investing in an HSA can go a long way towards maximizing retirement readiness.