If you're looking for one of the best tax deals around, look no further than a Health Saving Account (HSA) for its trifecta of benefits. Contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are not taxable.
To use an HSA, you must be enrolled in a qualifying high-deductible health insurance plan.
1. Powerful HSA can and should be part of your retirement saving plan
HSA savings could be especially valuable in retirement. A recent report from Fidelity estimates a healthy, 65-year-old couple retiring this year will need $275,000 to cover their health-care costs in retirement. Below are some best practices when you have decided on a health saving account.
1) Start by age 50, at the minimum.
If you haven't been able to get an earlier start, age 50 is a good point to begin focusing on using your HSA for retirement savings. That is because most likely you are in your peak earning years, and past the juggling of big family expenses such as college tuition. But if you can contribute to an HSA before that, do so by all means.
2) Maximize contributions.
If you're married, split your HSA savings into two accounts, with money in both your name and your spouse's. You'll still be limited to the maximum annual family contribution (currently $6,750), but then each spouse can make an annual $1,000 catch-up contribution once they reach age 55.
Workers who have access to an HSA, as well as a 401(k), may want to strategize which account they focus on first. Given that triple tax advantage of HSAs, in many cases it makes sense to set aside just enough in your 401(k) to get the full match, and then fund your HSA fully before circling back to top off your 401(k).
3) Invest consistently and wisely.
HSA contributions often default into a money market, but funds intended as long-term retirement savings should be invested as such. Compare investment options and fees at different providers. You can choose whatever provider you want, although if your employer provides a match, it may only do so with its preferred partner.
A small but growing number of consumers are investing their HSAs. As of mid-2017, HSAs held $6.8 billion in investment assets, representing about 16 per cent of all HSA assets, according to the quoted study. The average investment account holder has a balance of $15,146, including both deposit and investment accounts.
4) Avoid dipping into savings.
Here comes the tough part. If you can, pay for all current health expenditures out of pocket in order to "not spend a nickel" out of that HSA. That gives you a balance to roll over for future years and invest.
Reminder: Save those expenditures' receipts. There's no requirement that you claim medical expenses in the year that they occur; you can make a tax-free withdrawal even years later in retirement.
By one estimate, a couple putting aside the current annual maximum each year from age 50 to 65, and investing those funds, could amass nearly $230,000 more for retirement. A lot of times, it is the retirement years when health-care costs will be the greatest. So avoiding dipping into savings earlier will translate into more assets when you need them the most.
5) Weigh retirement decisions.
Under current rules, once you enroll in Medicare, you can no longer fund your HSA.
Keep that in mind as you approach age 65. Even if you're still working, you may be required to sign up for Medicare (with your employer's plan as secondary coverage), depending on the size of your employer and the kind of health plan you're on.
Claiming Social Security also by default enrolls you in Medicare Part A. So delay those enrollments if you can; or, at least, plan your HSA contributions accordingly.
2. What happens if you are no longer employed?
Unlike a flexible spending account, the money in your HSA remains yours even after you lose or leave your job. So you don't need to rush to the eye doctor or dentist to drain the account before your employment is terminated.
You can usually keep that money in your former employer's HSA, or you can roll it over to another HSA administrator without having to pay taxes on the move -- a lot like an IRA rollover. But ask first about any transfer fees. The money can then continue to grow in the account and can be used tax-free for future medical expenses in any year -- even if you no longer have a high-deductible health insurance policy.
If you declined or are not eligible for COBRA but will or have secured health insurance through the Health Insurance Marketplace, for example, you can make premium payments through an HSA if you are receiving unemployment insurance.
Also, if you were unable to fund your HSA by July 15, 2020, a one-time transfer is permitted from an IRA to an HSA. If the withdrawal is used for health insurance premiums, such as COBRA coverage, and/or if you are receiving unemployment benefits, you can effectively turn what would have been taxable IRA withdrawal dollars into a non-taxable HSA withdrawal.
3. What you need to know about the 2020 rules?
As we discussed earlier, you may contribute to an HSA only if you have a High Deductible Health Plan — generally a health plan, including a Marketplace plan, that only covers preventive services before the deductible.
For plan year 2020, the minimum deductible for a High Deductible Health Plan is $1,400 for an individual and $2,800 for a family. When you view plans in the Marketplace, you can see if they're "HSA-eligible."
If you have a High Deductible Health Plan, you can contribute up to $3,550 for self-only coverage and up to $7,100 for family coverage into an HSA. HSA funds roll over year to year if you don't spend them.
Some health insurance companies offer HSAs for their High Deductible Health Plans. Check with your company. You can also open an HSA through some banks and other financial institutions.
There is a once-in-a-lifetime rollover opportunity from IRA to HSA.
This may be one of the better news for people impacted by the 2020 pandemic. If you are thinking of taking this opportunity, please note the following rules:
You can rollover the amount equal to the annual HSA contribution limit, minus any contributions you've already made. For 2020, the limits are $3,550 for single health coverage and up to $7,100 for family coverage.
You must continue to be enrolled in an HDHP for 12 months after the transfer. If you don't, you will be liable for a tax penalty.