Health Savings Accounts (HSAs) can provide inexpensive medical coverage if you maintain a healthy lifestyle. With your healthy lifestyle you may not spend anywhere near your high deductible insurance and consequently save on your medical costs. Even if you do not need to, we recommend funding your account to the maximum allowed. If your HSA builds up it may help you cover any extra medical expenses during retirement.
An HSA is a tax-free savings account. As long as funds are spent on qualified medical expenses, all contributions, capital gains, and withdrawals remain untaxed. And like any other bank account, HSAs come complete with debit cards and checks.
But to qualify for one of these tax-free savings accounts, you must have a high deductible health plan (HDHP). Now, you may be thinking your insurance plan has a high enough deductible already. However, to qualify as a high deductible health plan, your insurance deductibles must be a minimum of $1,100 for individuals and $2,200 for families in 2007.
The good news is, once you meet your out-of-pocket deductible, most HSA-eligible high-deductible plans cover 100 percent of most medical expenses like emergency room visits, hospitalization, lab tests and prescriptions. Still, these deductibles are nothing to joke about. Paying a couple grand out of pocket before your insurance chips in may seem like financial suicide.
HSA-eligible high-deductible premiums are only a fraction of the cost of a traditional medical insurance plan. As an HSA owner you’ll likely do better than break even each year. With the savings on your insurance premiums, you should be able to accumulate a sizeable nest egg in your HSA.
Unlike your traditional health care plan, your HSA funds are not subject to a “use it or lose it” policy. Anything you don’t spend one year carries over to the next year. After all, it’s your money. While you’re on a roll, why not check out the invest options offered by your HSA bank?
Some people put only enough into their HSA each year to fund their medical expenses. This is shortsighted. We would recommend making the maximum HSA contribution each year, after covering your other financial needs.
In 2007, you can contribute $2,850 for individuals or $5,650 for families. If you are 55 or older you can make an extra $800 catch up contribution. In 2008, you can contribute $2,900 for individuals or $5,800 for families. If you are 55 or older you can make an extra $900 catch up contribution. (See the latest contribution limits here.)
Once you enroll in Medicare (typically at age 65) you can’t make new contributions to your HSA. But any money left in your HSA will continue to accumulate tax free. It is a good idea to over fund your HSA while you are young so that during your retirement you will have some extra tax-sheltered dollars to use for medical expenses. After enrolling in Medicare, you can’t contribute to an HSA.
Any HSA withdrawals that are not for qualified medical expenses are counted as taxable income and are subject to a 10% tax penalty. The tax penalty does not apply, however, if you are age 65 or older, or are permanently disabled. However, the withdrawals are still taxable at ordinary income rates.
In other words, any excess contributions you make to your HSA can be withdrawn after age 65 without penalty. Just like a traditional IRA, when the funds are used for non-qualifying medical expenses you will have to pay tax on the withdrawals, which is no different than other retirement savings options.
The law is currently silent on what happens to your HSA when you reach 70 1/2. We expect that the IRS will treat your HSA like an IRA and therefore require minimum distributions, but this has not been settled.
When you die, your surviving spouse inherits your HSA and it is treated as their HSA if they are named as the beneficiary. Otherwise, your HSA ceases to be an HSA and is included in the federal gross income of your estate or the named beneficiary.
There are three strategies that you can use to grow your HSA large enough to cover your retirement years. First, make the maximum allowable deposit to your HSA each year. Second, if your medical plan includes the option, invest your HSA in mutual funds instead of keeping your account entirely in an FDIC-insured savings account. And third, delay reimbursing yourself from your HSA account as long as possible to profit from its tax sheltered compounding interest.
You can reimburse yourself for qualified medical expenses at any time, but you also have the option of leaving the money in your HSA so that it continues to grow tax-free. You can save all your receipts in a shoe box for decades and then decide to withdrawal your reimbursements at any future date when you need the money. This allows the growth on these funds to continue to compound tax-free.
Once you turn 65 and enroll in Medicare you can no longer fund your HSA. Medicare will pay for the majority of your health expenses during retirement. There are some expenses, however, that Medicare will not cover that your HSA can. In retirement, your HSA can cover proactive health screenings, unconventional treatments for terminal illnesses and nursing home expenses. Your HSA can even cover long-term care expenses if you decide to self insure, or pay your long-term care insurance if you decide not to. None of these expenses will be paid by Medicare.
Another option during retirement is to enroll in a Medicare Medical Savings Account (MSA). This account is similar to an HSA, but funded in retirement by Medicare contributions. If you select a Medicare MSA during retirement, you can use the funds in your HSA until you build sufficient value in your Medicare MSA.
Maximizing your contributions to an HSA may secure your health care spending for life. Even if you end up not needing it, you can pay income tax and withdraw it without a penalty after age 65 just like a traditional IRA.
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