4 Ways Retirees Can Use Their HSAs
A health savings account, also known as an HSA, is the best retirement savings vehicle ever. It allows you to make contributions before taxes and withdraw money to cover qualified healthcare expenses. While saving, you can invest those funds and allow them to grow tax-free as well. You open the plan while employed in a high-deductible health plan. As of 2023, the plan limits allow for a maximum yearly contribution of $3,650 for individuals and $7,750 for families. In 2024, those limits will increase to $4,150 and $8,300, respectively. Additionally, individuals aged 55 to 65 can make a catch-up contribution of $1,000 per year. Once retired or reaching age 65, your HSA plan might be a significant portion of your nest egg. You may wonder how to utilize this account most efficiently. Let's take a look at some scenarios.
Healthcare Costs During Retirement
Future health expenses are less predictable pieces of the retirement savings puzzle. You will likely have a good idea of how much you spend on groceries, housing, vehicles, insurance, travel, and entertainment. But, how much should you budget for health care? According to the Center for Retirement Research at Boston College, the average retiree spends $4,311 on health costs in retirement. However, this amount could vary greatly depending on your income, the Medicare supplement plan you choose, and medical treatments.
If you started saving in an HSA plan in 2004 when you were 45, how much will you have saved in 2024 when you retire at 65?
Back then, the maximum contribution allowed for a family was $5,150. Let's say you didn't know you could increase your annual contributions based on the yearly contribution limit, and you continued to save only $5,150 at the beginning of every year for 20 years. You invested those funds into a conservative fund and earned a modest 3% annual return. Your HSA account will be approximately $147,500 when you retire next year.
Now, let's say you have a financial advisor like Hurlow Wealth Management Group who reminds you during your annual comprehensive review to increase your HSA contributions every year. You would have increased your contributions by about $40,000, but your account value would likely exceed $325,000 at retirement. The growth is due to both the investment choices and maximizing contributions. So don’t forget to check that you are maxing out your HSA and investing for optimal growth.
The best use of your HSA account is to allow your funds to grow and utilize your HSA for qualified healthcare expenses in retirement. The true power of an HSA lies in its ability to compound and grow over time.
Once you reach the age of 65 and enroll in Medicare, you can no longer contribute to an HSA, and as a retiree, you have a few optimal ways to spend your funds from your account in the most tax-advantageous manner.
1) Qualified Medical Expenses
When you take a distribution from an HSA for a qualified medical expense (QME), is is always tax-free and penalty-free. We think of medical expenses as going to the doctor, dentist, or buying medication. But did you know that you could modify your home as a qualified medical expense?
The IRS defines Medical expenses as "the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes." So, home modifications such as handrails or widening entrance doorways qualify as medical expenses. To see a complete list of QMEs, go to: https://www.irs.gov/publications/p502
One note about Medicare premiums: Parts B and D and Medicare Advantage plans are considered QMEs, but premiums for Medicare supplement policies are not.
2) Save Your Receipts
Throughout your working years, keep your receipts as proof of qualified medical expenses. You do not need to take distributions during the same year you have a QME. Instead, let the account value grow and the interest compound and save your receipts. Then, when you reach retirement age, you can take a distribution for any reason. For example, over twenty years, you have $100 in annual medical and dental co-pays, $200 for prescriptions, $250 for eyeglasses every two years, and a one-time hospital expense of $6,500. You can take out $15,000 in retirement and use those QME receipts from prior years to pay for a trip, a down payment on a car, or anything else you want to buy tax-free.
3) Like An IRA
Qualified medical expense distributions from your HSA do not count towards your modified adjusted gross income. As a result, they do not affect retirement-related taxes such as Medicare premiums or Social Security benefits. At age 65, you can also use HSA distributions to cover non-medical expenses. While these payouts are not tax-free, there is no penalty in retirement so you can treat them as the same as distributions from a traditional IRA. This means that your distributions will be taxed at ordinary income rates.
4) Designate A Beneficiary
When setting up your HSA, you can choose who will receive the funds in the event of your death. Typically, you will complete a beneficiary designation form provided by your HSA company. If you designate your spouse as the beneficiary, he or she will inherit your HSA tax-free and have the ability to continue using the account as their own. It's worth noting that certain HSA companies may automatically assign your spouse as the beneficiary if you haven't specified one, but it's always good to double-check. If you choose a non-spouse beneficiary, your HSA will be closed upon your passing, and the tax will be due in the year of your death, so this is not an ideal account to pass to children. It's better to spend it down in your lifetime. However, if you die owing medical bills, your heirs can pay those expenses with your HSA proceeds for up to one year after death.
If you are unsure if you are maximizing your Health Savings Account, either during your working years or in retirement, contact one of the advisors at Hurlow Wealth Management Group. For over two decades, our financial advisors have acted as fiduciaries, helping our clients evaluate employee benefits as part of their financial plans. Click here to schedule a call with a fiduciary today.