Health Savings Accounts Help Maximize Tax-Free Retirement Benefits

Health care costs can be a significant expense in retirement. It is sometimes overlooked or underappreciated, posing challenges when planning for retirement. How much new retirees can expect to pay for health care depends on who you ask.

The annual Fidelity Retiree Health Care Cost Estimate projects that a 65-year-old couple retiring in 2022 is likely to spend an average of $315,000 on health care and medical expenses during their retirement. This estimate assumes the couple enrolls in traditional Medicare Parts A, B and D.

If you think that estimate is too high, consider this. Research by the Employee Benefit Research Institute (EBRI) estimates that a man who turned 65 years old in 2021 and had $79,000 in retirement savings earmarked for health expenses only had a 50/50 chance of covering Medicare premiums and median prescription drug expenses, while a 65-year-old woman with $103,000 available to pay for these costs faced the same odds. To have a 90% chance of covering these expenses for their entire retirement, the man would need $142,000 and the woman would need $159,000.

With health care inflation continuing to increase, these numbers will only go up over time.

Answering The Health Care Question

Numbers like these are the reason a health savings account (HSA) could be an important part of your financial plan. The beauty of the HSA is that it offers triple tax benefits:

1. The money you contribute to your HSA is tax deductible if you are enrolled in a high-deductible health insurance plan (HDHP).
2. The money in the HSA grows tax free and can be invested as you see fit.
3. Any money in the HSA, including investment earnings, that is used to pay for eligible health, dental and vision services can be withdrawn tax free.

The key is that you must be enrolled in a HDHP, which must have a deductible of at least $1,400 for an individual or $2,800 for a family in 2022. If you are self-employed or retired but not yet eligible for Medicare, finding a HDHP is relatively straightforward. You can focus your shopping on those plans that meet the HDHP criteria.

If you are employed, your employer may offer a HDHP or even partially fund an HSA on your behalf. If your employer does not offer a HDHP, it never hurts to ask them to add one to the health insurance menu they offer.

Once enrolled in the HDHP, your financial advisor can help assist in choosing appropriate investments for long term investing. You can contribute a maximum of $7,300 for family coverage or $3,650 for single coverage for the 2022 plan year. If you are over the age of 55, you may make an annual “catch-up” contribution of up to $1,000 each year.

Creating A Pool Of Assets For A Healthier Retirement

By contributing to an HSA before retirement, the power of compounding investment returns could create a significant pool of assets over time to cover health care expenses in retirement, including long-term care. This is especially true if you have the ability to pay out-of-pocket for your medical expenses instead of using your HSA during your working years.

If you are lucky enough to enjoy robust health throughout your life with lower health care spending, you can still benefit from having the HSA. As you incur and pay health care expenses out of pocket while you are funding the HSA, keep the receipts and other proof of those payments in a safe place. You can use those expenses to make a tax-free HSA withdrawal whenever you want.

If you are married, the HSA–and all of its tax advantages–automatically becomes the property of your spouse when you die. If you are not married at the time of your death, your heirs can inherit your HSA but will have to pay taxes on those assets within a year of your death. Adding a beneficiary designation to your HSA can help keep those assets out of probate.

Once you turn 65 and apply for Medicare, you are no longer eligible to participate in an HDHP and, therefore, can no longer contribute to your HSA. However, you can use HSA funds to pay for Medicare premiums (Parts B, C & D), copays, deductibles, and coinsurance, as well as qualified long-term care insurance premiums or expenses. Unfortunately, you cannot use HSA funds to pay for Medigap policy premiums.

Worried about the rising costs of healthcare in retirement? Talk to your financial advisor about how to plan for these costs as part of your comprehensive financial plan.