Recent studies have estimated that a person who is retired for 20 years will need about $132,000 during retirement for out-of-pocket health care expenses. Fidelity.com estimates that an average 65-year-old will spend $551 monthly, or $6,631 annually, for premiums, co-pays, deductibles, dental, vision, hearing, and prescriptions.
What can you do to help cover these formidable expenses?
One approach is to contribute to a Health Savings Account, or HSA, before you retire. These accounts are relatively new, but they are receiving much attention from Congress, employers, consumers, and financial institutions as a tax-favored savings vehicle for health care expenses. Created by the Medicare Prescription Drug and Modernization Act of 2003 and implemented in January, 2004, they permit eligible individuals to contribute pre-tax dollars to an account for payment of future medical expenses. HSAs can also serve as a retirement savings account to be used for non-medical expenses after age 65.
What is a Health Savings Account (HSA)?
Like an IRA, an HSA is funded with pre-tax money that also grows tax free. However, unlike an IRA, withdrawals are not taxed if used for qualified health care expenses, including non-prescription drugs. Moreover, you can use your HSA to pay for qualified medical expenses for your spouse and your dependents as well as yourself.
Contributing to an HSA has other advantages: It reduces your taxable income, and you control the tax-exempt account. The trustee or custodian (bank, insurance company, financial institution) for the account typically offers a range of investment options you can choose from.
Eligibility for HSAs
To be eligible to contribute to a HSA, you must be covered by a High Deductible Health Plan (HDHP). Your employer may offer this, or you can purchase one on your own. These plans are inexpensive and are sometimes called catastrophic health insurance plans. In 2007, your HDHP must have an annual deductible of at least $1,100 for self-only coverage and $2,200 for family coverage. An HDHP also has annual out-of-pocket limits (including deductibles and co-pays), which cannot exceed a total of $5,500 for self and $11,000 for family in 2007.
You are not eligible to open an HSA if any of the following apply:
- You are enrolled in Medicare.
- You can be claimed as a dependent on another person's tax return.
- You are covered by a non-HDHP.
Contributions to HSAs
If you max out on your 401(k) plan contributions but want to make additional tax deductible contributions, an HAS may be an ideal means to do that.
In 2007, you can contribute 100 percent of your deductible to an HSA, or up to $2,850 for self-only coverage and $5,650 for family coverage. If you are age 55 or older, you can make a catch-up contribution of up to $800 more.
There are no income-level restrictions on contributions; anyone, regardless of income, can contribute until age 65. However, you cannot contribute to an HSA after age 65.
Qualified medical expenses
Medical expenses that are deductible on your tax return are known as Section 213(d) deductions; this refers to a section of the Internal Revenue Code. These same expenses are qualified expenses for HSA tax-free withdrawals. Other out-of-pocket health care expenses that are not tax deductible may also be paid from your HSA balances. In general, you can use HSA funds to cover insurance deductibles, co-pays, eye care, dental work, hearing correction, prescriptions, over-the-counter (non-prescription) drugs, and health insurance premiums if you are collecting unemployment benefits. Cosmetic surgery or cosmetic dentistry are not qualified medical expenses.
You can also use the funds in your HSA for Medicare premiums, COBRA premiums, retiree medical insurance premiums, and long-term care premiums. You cannot use your HSA to purchase Medicare supplemental insurance (Medigap) policies. Paying long-term care premiums out of an HSA is especially beneficial if you cannot deduct the premiums.
Unlike the flexible spending/health care reimbursement accounts that employers offer, you can carry over balances in your HSA from year to year. They can continue to grow tax free.
Withdrawals for non-qualified expenses
What if you are desperate for cash and withdraw money from your HSA for non-medical reasons? Such withdrawals are considered taxable income and are subject to an additional 10 percent penalty. This penalty does not apply if the withdrawal is made as a result of death or disability, or after you attain age 65.
Because there is no penalty after you turn 65, you can use an HSA as a tax-deferred savings vehicle for retirement. Of course, if you make withdrawals for non-medical expenses, they will be taxable -- just as are distributions from other retirement plans and traditional IRAs.
Although you cannot roll over HSA funds to an IRA, you can roll them over to another HSA. You must do this within 60 days of withdrawal in order for the funds to remain tax exempt. Doing a direct transfer from trustee to trustee can help you to avoid complications.
Establishing an HSA
If you meet the requirements, you can establish an HSA through any qualified trustee or custodian, including a bank, credit union, insurance company, or other approved company. Almost 1,100 banks across the US now offer them; comparison shopping is worthwhile, as fees and interest rates vary widely. Wherever you apply, you will be required to submit an application, documentation of your enrollment in a HDHP, and any deposits you need to open the account. Some HSA administrators have electronic forms on their Web sites.
If you are still working, your employer may offer an HSA option as part of your health care coverage. Some offer an employer-funded or -sponsored HSA in combination with an HDHP. More large corporations are adopting such plans to reduce their health care benefit costs, and a report by the international consulting firm BearingPoint projected that 70 percent of all employers will offer HSAs within the next two years.
To learn more about HSAs, visit http://www.treas.gov/offices/public-affairs/hsa
NOTE: The information provided in this article is meant to enhance the understanding of retirement planning. It does not suggest or imply tax, financial, or legal advice nor does it constitute such advice. Consult your financial advisor about the facts and circumstances of your own unique situation.
References and sources
Forefield Advisors, Health Savings Accounts, 2006
U.S. Department of The Treasury, The Basics of HSAs, 2006
The Wall Street Journal, Banks Pile Into HSAs, Nov 14, 2006
Investment News, Some Predict HSAs to be Next IRAs, Oct 23, 2006
Journal of Financial Planning, October, 2006
posted by Johannabartley
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