By Mike Guarino
Healthcare costs. Just those two words are enough to give anyone anxiety. Even if you have comprehensive health insurance, just one hospital visit could cause you to deplete your emergency fund or force you to dig into your long-term savings to avoid going into debt. That’s why it’s not surprising that many Americans fear medical bills more than the underlying illness. (1)
Luckily, there are many tools like tax-advantaged healthcare spending accounts that you can use to prepare for costly healthcare bills. A Health Savings Account, or HSA, is one of the best tools to invest and prepare for healthcare costs. This account allows employees to make tax-free contributions and distributions for qualified healthcare expenses. If you’re eligible for an HSA (i.e., you hold a high-deductible insurance plan), here’s how to take full advantage of it.
Set Up Automatic Contributions
Most employers allow employees to contribute to an HSA via payroll deductions. This method can make it simple to grow a significant HSA balance over time. Keep in mind that HSA contributions are pre-tax, meaning that these contributions won’t be subject to federal, state, or FICA taxes.
Another great feature of payroll contributions is the employer match, which generally ranges from $1,000 to $2,000 per year. An employer’s contribution can be a lump sum or divided into quarters and is generally higher for married employees. Keep in mind that these contributions reduce your maximum annual HSA contribution. So a married employee can only contribute $5,000 to his or her account instead of the current limit of $7,000 if their employer contributed $2,000.
Use It For Eligible Expenses
The funds can be used for eligible expenses which are determined by the IRS, including costs that aren’t usually covered by health insurance plans, such as deductibles, co-insurance, prescriptions, and dental and vision care. (2) Most things that would typically qualify for the medical expense deduction on your tax return qualify for an HSA.
Health insurance premiums are generally not considered IRS-qualified expenses unless they are for qualified long-term care insurance, COBRA healthcare continuation coverage, or healthcare coverage while an individual is receiving unemployment compensation. For people over 65, qualified expenses include premiums for Medicare parts A, B, D, and Medicare HMA, the portion an employee pays for employer-sponsored health insurance, and the employee portion of employer-sponsored retiree health insurance. Supplemental policies like Medigap are not considered qualified by the IRS.
Qualified expenses can be paid directly from the Health Savings Account by check or debit card. Reimbursements are also allowed for previously paid medical expenses, as long as the expense was incurred after the establishment of the HSA. There is no statute of limitations for reimbursements as long as the HSA was in existence at the time of the expense.
However, you can’t contribute to an HSA if you enroll in Medicare, which is why you should tell your provider to stop making contributions well in advance before enrolling.
Use It For Retirement
The obvious and typical use of an HSA is to pay for medical expenses as they occur. Many people, however, have turned their account from a current pay-as-you-go way of avoiding taxes on medical expenses to a lucrative retirement savings vehicle. They pay for current medical expenses out of pocket but maximize their HSA contributions and just let them grow for use during retirement.
It is no surprise that healthcare is often a major expense in retirement. The Employee Benefits Research Institute estimates that the average couple will need $265,000 to be 90% confident they will be able to take care of out-of-pocket medical expenses during retirement, (3) and 41% of Americans are worried about how to pay for healthcare in their later years. (4)
Since medical costs are such a significant aspect of your retirement financial needs, it makes sense that an HSA can be used for retirement savings. Your HSA should not be your only retirement savings vehicle since funds are only tax-free for qualified medical expenses. But when used in conjunction with IRAs and 401(k)s to pay for non-medical expenses, they can be a very powerful way to build your nest egg. After all, an HSA receives better tax treatment than any IRA or 401(k), whether traditional or Roth.
There is one caveat, though. In order to use an HSA for retirement savings, you need to make sure it is invested properly for long-term growth. Keeping HSA money in a traditional savings account earning .5% interest may be a good idea for those who are using the money for current expenses, but to do that for retirement savings would be to miss out on years and years of tax-free growth.
The Bottom Line
The ins and outs of a Health Savings Account can be confusing. If you want to avoid headaches, work with a knowledgeable financial professional who can walk you through the fine print. If you want to know more about Health Savings Accounts and how to make the best choices for retirement in a tax-efficient manner, I’d love to help! Call our office at (973) 625-1112 or email firstname.lastname@example.org to schedule a meeting today.
Michael J. Guarino III, Wealth Advisor, CDFA®, is an innovative wealth advisor specializing in custom financial strategies for corporate executives and professionals from coast to coast.
Mike worked as a manager in information technology for 12 years at the headquarters of a Fortune 500 company before starting his own wealth management company, Guarino Wealth Management, in 2008. He knows what a day in the life of a busy corporate professional is like, and he chose to make his specialization in working with corporate executives and professionals.
Mike has a bachelor’s degree from William Paterson University and has diverse backgrounds in information technology as well as finance. He combines these two disciplines to provide specialized, comprehensive, and custom financial strategies to his clients.
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