- Thanks to an upfront tax deduction and tax-free growth, HSA accounts are better than Roth IRAs.
- Maximizing your annual HSA contribution and delaying reimbursement of your medical expenses in future years, allows your assets to grow tax-free.
- Keep your medical expense receipts. These can be used many years later for tax-free reimbursements.
As healthcare and insurance costs keep rising, many companies and individuals are turning to high deductible health insurance plans to reduce the cost of their medical insurance. At first blush, paying a higher deductible seems like just one more hit to your pocketbook. But, for individuals who manage their healthcare costs wisely, and who contribute to Health Savings Accounts (HSAs) with a long-term plan in mind, this strategy may be a great way to create a tax-free bucket of income during retirement. Better yet, you receive a tax deduction since the money is contributed to the HSA account!
For 2018, a high deductible health insurance plan is one with a deductible of at least $2,700 for a family ($1,350 for an individual). If the plan qualifies as a high-deductible plan, then you can contribute up to $6,850 per year into a HSA account for a family ($3,450 per year for an individual). If you are 55 years of age or older, you can make an additional $1,000 contribution. Again, these HSA contributions are deductible, and if the funds are used for healthcare costs, then the distributions are tax-free. What’s not to like?
Taking an Investment Approach to HSAs
The typical approach is to contribute to the HSA account throughout the year and then make tax-free distributions as needed for healthcare and dental expenses. However, if you have the budget, a better option is to delay distributions from your HSA account and invest the funds for the long-term. Essentially, you’re creating a Roth account with the added benefit of an upfront tax deduction.
When it comes to HSAs, here’s what we recommend to our clients:
1. Set up your HSA account. If you are an employee, your company probably requires you to use a specific HSA company. If you are a business owner or individual, you have more flexibility and can select a company with low-cost investments and a reasonable cost structure. Providers such as www.healthsavings.com offer investment options through Vanguard and Dimensional Fund Advisors, for example.
2. Maximize your annual contributions to the HSA account of $6,850 per year for a family or $3,450 for an individual. Don’t forget to make the additional $1,000 contribution if you are 55 years or older.
3. Establish a cash position that you would like to maintain for unexpected and large medical expenses. Some plans require you to maintain a minimal amount of cash prior to investing.
4. Invest the remainder in a diversified investment portfolio to be held for the long-term.
5. Save your healthcare receipts for reimbursement in the future. One amazing benefit of an HSA account is that there is no deadline for reimbursement. Therefore, you could incur an expense now and reimburse yourself 20 years later, all while allowing your assets to grow tax-free over the 20 years.
HSAs in Retirement
Once you are retired, you have the following options for using distributions from your HSA account:
1. Reimburse yourself on a tax-free basis for prior year expenses for which you have maintained receipts.
2. Pay for healthcare and dental expenses incurred during the current period.
3. Pay for continuation coverage under COBRA. Note that you generally cannot reimburse yourself for medical insurance premiums.
4. Pay for qualified long-term care insurance premiums.
5. For account holders age 65 and over, pay for premiums on health insurance, including Medicare Parts B & D premiums.
If you’re under age 65, funds used to pay for non-eligible medical expenses are subject to normal income tax and a 20 percent penalty. After age 65, your funds may be withdrawn for non-eligible expenses with no penalty but regular income tax will apply. Medicare supplement (Medigap) policy premiums are not included.
Plan for the Future
This HSA strategy is one of the many ways that Soundmark helps clients maximize savings options and manage taxes as part of our life and retirement planning process. Let us know how we can help you and your family plan for the future.
Todd Flynn, CPA, CFP® is a Principal at Soundmark Wealth Management, LLC. Todd works closely with physicians, business owners, and other successful and accomplished individuals to help them define their financial goals and implement an ongoing financial planning process.