While most people choose a High Deductible Health Plan to lower ongoing health insurance premiums, consider using a health savings account or HSA to help fund future health care expenses in retirement.
With health insurance premiums continuing to rise, many individuals and families are choosing an insurance plan with a high deductible to curb their current medical insurance premium costs. High deductible plans, formally High Deductible Health Plans (HDHP), provide an added benefit: the ability to contribute to a health savings account (HSA) to help pay for current or future health care expenses.
An HSA is a savings account that enables someone with an HDHP to set aside tax-free funds to pay for a doctor visit or other out-of-pocket qualified medical expenses. The tax savings and ability to build a sizable balance may help those with HSAs lower their overall health care costs both short-term and in some situations in retirement.
People can only set aside funds in an HSA if they have an “HSA-eligible” HDHP medical plan in the year of their contribution. “High deductible” plans vary from a deductible of at least $1,350 up to $4,800 for an individual, and double that for a family.
Opting for a high deductible plan makes people wary of potential out-of-pocket costs if they have an accident or get sick. However, the premium difference and tax savings between the HDHP and a low deductible plan often covers the ordinary out-of-pocket healthcare related costs. Additionally, after a few years of saving up in an HSA, enough funds should be set aside to cover the maximum out of pocket expense for any given plan year.
For 2018, someone with an individual policy can contribute up to $3,450 in an HSA and up to $6,900 for family HDHP coverage. Those age 55 and older in the calendar year can contribute an additional $1,000.
Unlike a flexible spending account (FSA), there is no “use it or lose it” rule. Funds remaining in an HSA can be carried over year after year and grow tax-free to cover future health care expenses if not needed. In other words, an HSA is like a health care IRA, except withdrawals can be made whenever needed for health care expenses without incurring a penalty.
For example, an individual contributing the $3,450 maximum in 2018, who then uses $1,000 in doctor visits and prescriptions, would have $2,450 remaining at year-end to which an additional $3,450 (or amount set annually by the IRS) can be added in 2019.
HSA’s also offer a triple federal tax benefit. Funds put into an HSA are tax-deductible. Provided the money is used for qualified health care expenses, withdrawals are tax-free. Lastly, any interest, dividends, or capital gains the HSA accumulates are not taxed. Most states give HSAs the same tax treatment, adding to the savings.
Funding Retirement Health Care Costs
When HSA balances are large enough, a brokerage account can be opened which allows funds to be invested tax-free. If an individual is lucky enough not to incur medical expenses or chooses to fund these expenses out of pocket instead of tapping into HSA funds, there may be a better alternative:
HSA funds can be saved for long-term needs. J.P. Morgan illustrates below that by contributing for 30 years today’s maximum allowed with a 6 percent rate of growth amounts to $370,000 in tax-free dollars to be used for health care expenses in retirement. With total contributions amounting to only $145,574, nearly $225,000 in potential tax-free earnings are generated.
Health care costs are high and rising annually. Besides the inflationary increases, people typically incur more health care expenses as they age. A couple currently age 65 can expect to spend an average of $275,000 during their retirement on health care expenses, even with Medicare.
Having an HSA and HDHP can save you money on health care costs now and help pay for future expenses. Their tax and retirement-saving advantages are enticing, making their flexibility to be used when needed now or in retirement a useful feature. If you’d like more information on HDHP’s and/or HSA’s, we recommend you reach out to your HR group or an insurance professional.
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