Saving, or reserving current income, for your future is the key to increasing the odds that you’ll be able to retire with a more secure financial future. Once you master saving, then focusing on investing and planning become important. There’s no sense spending time thinking about investment options when you haven’t saved any money. It’s also silly to make plans on spending your retirement assets when you haven’t set any aside.
In the last two posts, the focus was on saving in an employer sponsored retirement plan or in an IRA. The steps used in setting up a system to save in an IRA can also be used to establish a regular investment account as well.
Another tax advantaged way to save is using a Health Savings Account (HSA) to help fund your retirement. HSAs are becoming more widely available as employers move away from more traditional health care insurance to high deductible health plans. High deductible plans generally have lower premiums but also come with higher deductibles. This essentially encourages employees to become more cost conscience in sourcing their health care by shifting more cost onto the employee.
Similar to 401(k) or 403(b) accounts, HSAs are typically funded through payroll deductions making it extremely easy for employees to participate. Many employers also make a contribution to the account to encourage participation as well. Contributions are rather limited each year. For singles, the limit is $3,500 per year and for families (or married couples) the limit is $7,000. The annual limit includes any employer contributions to the account. If you are age 55 or older, there’s a $1,000 “catch-up” contribution.
While the contribution amounts may seem small compared to a 401(k), the tax benefits are tremendous with triple tax savings:
- Your contributions are tax deductible,
- The account grows tax deferred, and
- Withdrawals, when used for medical expenses, are tax free.
A pre-tax 401(k) or Traditional IRA only provide the first two benefits but withdrawals are subject to taxes. A Roth 401(k) or Roth IRA provide the last two tax benefits, but not the first. An additional tax benefit that is often overlooked is that your contributions to an HSA are not subject to FICA withholding unlike contributions to an IRA or 401(k). That’s another 7.65% in tax benefits each year based on your contributions.
HSAs can continue to grow each year and don’t have a risk of forfeiture like Flexible Spending Accounts (FSA). That’s what makes these accounts so powerful. While most employees use the accounts to pay for current medical expenses during the year, there are tremendous benefits if you leave the account alone. If you pay out of pocket for your medical expenses rather than using the HSA, your HSA can fund a significant portion of health care expenses tax free in retirement.
Fidelity has been publishing projected health care costs for many years. In the most recent post, they project a 65 year old couple retiring in 2019 will spend $285,000 in health care and medical expenses over their retirement. That’s a huge amount for just one category of a retirement budget. [For more detailed projections for singles based on gender as well as more information, I encourage you to read their release.]
Funding an HSA, if available to you, (and not dipping into it for your current medical expenses) can take considerable pressure off other investment and tax deferred accounts in retirement. Consider the following example of a 30 year old couple that has access to an HSA account and with the help of their employer contributes the maximum amount of $7,000 for ten years. If the couple then stops funding the account and allows it to grow until age 65, the balance is approximately $540,000 (compounding annually at 7%).
If the couple were to withdraw 4% of the account each year starting at age 65 until age 100, they would be able to spend over $1.3 million toward their medical and health care expenses.
As you can see from both the table and the chart, the account can accumulate over time creating substantial value. Should you or your spouse ever need long term care or nursing care, the HSA can be tapped to cover those expenses as well.
It should be noted that sometimes the investment options are lacking or limited in employer plans which could put a damper on compounded growth over a long period of time. There is, however, a solution – transfer your balance (even while still employed) to a Personal HSA account. While there isn’t a large market yet for Personal HSA providers, it is growing. It’s growing for a reason, providers are beginning to realize that account balances in HSAs are growing larger and that creates opportunity for them.
I recently transferred my balance from my previous employer’s plan to a Fidelity HSA account (understand I am not endorsing Fidelity but merely relating my personal experience). My previous employer offers a terrific HSA plan and has many excellent investment options available. However, as a former employee, my account became subject to monthly fees which created a drag on the account. The transfer did take about 4 weeks which I have read is not unusual. The Fidelity HSA is much like a brokerage account with no monthly fees and access to a broad array of investment options.
As for planning, you can name your spouse as the beneficiary of the account and they can continue to use it for their ongoing medical and health care expenses after you’ve passed. If you do not have a spouse, you can name anyone as the beneficiary although the account becomes fully taxable upon distribution. Non-spousal beneficiaries are not allowed to use the account on a tax free basis for their medical expenses. It’s for this reason that an HSA is not ideal for legacy planning.
HSAs can play a critical role in paying for one of the largest expenses we may face in retirement. The triple tax advantages it offers are a fantastic incentive to incorporate the account into your retirement planning. HSAs take a burden off your investment and tax deferred accounts to pay, tax free, a portion of your health care expenses in retirement. The ease of payroll deductions makes it an ideal way to save today. You should intentionally use the account for medical expenses in retirement rather than paying for your current health care expenses. This creates an exceptional opportunity to offset health care, long-term care, or nursing expenses during retirement in a tax advantaged way.
Are you using an HSA? Are there other features of the account that you use? Feel free to share your experiences in the comments below.
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