Longer life expectancies and rising health care costs make saving for retirement more important than ever before. A Health Savings Account (HSA) can be a powerful tool for financing health care expenses while supplementing your other retirement savings vehicles. And it offers estate planning benefits to boot.
An HSA in Action
Similar to a traditional IRA or 401(k) plan, a HSA is a tax-advantaged savings account funded with pretax dollars. Funds can be withdrawn tax-free to pay for a wide range of qualified medical expenses. (Withdrawals for non-qualified expenses are taxable and, if you’re under 65, subject to penalties.)
To provide these benefits, a HSA must be coupled with a high-deductible health plan (HDHP). For 2019, a HDHP is a plan with a minimum deductible of $1,350 ($2,700 for family coverage) and maximum out-of-pocket expenses of $6,750 ($13,500 for family coverage). In addition, you must not be enrolled in Medicare or covered by any non-HDHP insurance (a spouse’s plan, for example). Once you enroll in Medicare, you can no longer contribute to a HSA, but you can continue to withdraw funds to pay for qualified expenses.
Currently, the annual contribution limit for HSAs is $3,500 for individuals with self-only coverage and $7,000 for individuals with family coverage. If you’re 55 or older, you can add another $1,000. Typically, contributions are made by individuals, but some employers contribute to employees’ accounts.
HSAs can lower health care costs in two ways: by reducing your insurance expense (HDHP premiums are substantially lower than those of other plans) and allowing you to pay qualified expenses with pretax dollars.
In addition, any funds remaining in a HSA may be carried over from year to year, continuing to grow on a tax-deferred basis indefinitely. This is a huge advantage over health care Flexible Spending Accounts, where the funds must be spent or forfeited (although some employers permit employees to carry over up to $500 per year). When you turn 65, you can withdraw funds penalty-free for any purpose (although funds that aren’t used for qualified medical expenses are taxable).
To the extent that HSA funds aren’t used to pay for qualified medical expenses, they behave much like an IRA or a 401(k) plan.
Estate Planning and Your HSA
Unlike traditional IRA and 401(k) plan accounts, HSAs do not have required minimum distributions once you reach age 70½. Except for funds used to pay qualified medical expenses, the account balance continues to grow on a tax-deferred basis indefinitely, providing additional assets for your heirs. The tax implications of inheriting a HSA differ substantially depending on who receives it, so it’s important to consider your beneficiary designation.
If you name your spouse as beneficiary, the inherited HSA will be treated as his or her own HSA. That means your spouse can allow the account to continue growing and withdraw funds tax-free for his or her own qualified medical expenses.
If you name your child or someone else other than your spouse as beneficiary, the HSA terminates and your beneficiary is taxed on the account’s fair market value. It’s possible to designate your estate as beneficiary, but in most cases that’s not the best choice, because a beneficiary other than your estate can avoid taxes on qualified medical expenses paid with HSA funds within one year after death. When the estate is the beneficiary, the entire value of the HSA is taxable to you on your final income tax return. This presents a planning opportunity, particularly if you’re in a lower tax bracket than the beneficiary or beneficiaries of the HSA.
A Flexible Tool
A HSA is a flexible tool that can be used to reduce health care costs, supplement your retirement savings, provide additional wealth for your heirs or all three. It’s particularly attractive for those who are prevented by income limits from contributing to a deductible IRA. Like IRAs, HSA products have different investment choices and fees, so be sure to review your options and select an account that meets your needs.