Using Your HSA to Build Retirement Savings

Health Savings Accounts are an excellent way to build a second retirement account.  These tax-favored accounts, which have only been available since January of 2004, can be opened by anyone with a qualifying high-deductible health insurance plan.  Once you open an HSA account, you can place tax-deductible contributions into it, which grow tax-deferred like an IRA.  You may withdraw money tax-free to pay for medical expenses at any time.

HSAs: A Tax-free Medical Investment Fund and Additional Retirement Account

The biggest reason more people don't retire before age 65 is lack of health insurance, and many Americans reach age 65 woefully unprepared for the medical expenses they'll face once they do retire.  One of the most important long-term reasons for establishing an HSA is to build up some money for medical expenses incurred during retirement.

Fidelity Investments reports that the average couple retiring in 2007 will need $215,000 just to cover medical expenses during retirement.  This estimate, up an average of 5.8 percent a year since 2002, includes the cost of Medicare Part B and Part D premiums, co-payments, deductibles and excluded benefits, and of out-of-pocket costs for prescription drugs.  It does not even include the cost of over-the-counter medications, most dental services and, if needed, long-term care.  Add those, and the Employee Benefit Research Institute reports that you’ll need $295,000.  This assumes life expectancies of 15 years for the husband and 20 years for the wife.

Since medical costs are rising more than three times faster than salaries, Americans "should be calculating and factoring life-long health-care expenses into their overall financial planning," says Brad Kimler, a Fidelity executive.

HSAs are, without exception, the best way to build up money to pay for medical expenses during retirement.  You should not contribute any money to your traditional IRA, 401 (k), or any other savings account until you have maximized your contribution to your HSA.  This is because only health savings accounts allow you to make withdrawals tax-free to pay for medical expenses.  You can take these distributions anytime before or after age 65.

Your HSA contributions won't affect your IRA limits -- $3,000 per year or $3,600 for those over 55.  It's just another tax-deferred way to save for retirement, with the added advantage being that you can withdraw funds tax-free if they are used to pay for medical expenses.

For early retirees who are healthy, a health savings account can also be a smart option to help lower their health insurance costs while they wait for their Medicare coverage.  The older someone is, the more they can save with an HSA plan.  For many people in their 50's and 60's who are not yet eligible for Medicare, HSAs are by far the most affordable option.

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How Much Can You Save with an HSA?

Any money you deposit in your health savings account is 100% tax-deductible, and the money in the account grows tax-deferred like an IRA.  For 2007, the maximum contribution for a single person is $2,850.  For families, the maximum contribution is $5,650.

If you're 55 and older, you can put in an extra $800 catch-up contribution in 2007, $900 in 2008, and an additional $1,000 from 2009 onward.  The contribution limit is indexed to the Consumer Price Index (CPI), so it will increase at the rate of inflation each year.

Future Value of Your HSA Account

How much you accumulate in your HSA will depend on how much you contribute each year, the number of years you contribute, the investment return you get, and how long you go before withdrawing money from the account.  If you regularly fund your HSA, and are fortunate enough to be healthy and not use a lot of medical care, a substantial amount of wealth can build up in your account.

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HSA Investment Options

Health savings accounts are self-directed, meaning that you have almost total control over where you invest your funds.  There are numerous banks that can act as your HSA administrator.  Some offer only savings accounts, while others offer mutual funds or access to a full-service brokerage where you may place your money in stocks, bonds, mutual funds, or any number of investment vehicles. 

How Tax-deferred Growth Accelerates Your Retirement Account Growth

One of the biggest advantages of retirement accounts like HSAs are that the funds are allowed to grow without being taxed each year.  This can dramatically increase your return.  For example, if you are in the 33% tax bracket, you would need a 15% return on a taxable investment to match a tax-deferred yield of only 10%.

As another example, if you are in a 33% tax bracket and were to invest $5,650 each year in a taxable investment that yielded a 15% return, you would have $312,149 after 20 years.  If you put that same money in a tax-deferred investment vehicle like an HSA, you would have $558,317 - over $240,000 more.

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Strategies to Maximize your HSA Account Growth

If your objective is to maximize the growth of your HSA in order to build up additional funds for your retirement, there are three important strategies you should implement.

Strategy #1: place your money in mutual funds or other investments that have growth potential.  Though this is riskier than placing your money in an FDIC-insured savings account, it is the only way to really take advantage of the tax-deferred growth opportunity that an HSA provides.

Strategy #2: delay withdrawals from your account as long as possible.  Though you may withdraw money from your HSA tax-free at any time to pay for qualified medical expenses, you do have the option of leaving the money in the HSA so that it continues to grow tax-free.  As long as you save your receipts, you can make medical withdrawals from your account tax-free at any future date to reimburse yourself for medical expenses incurred today.

As an example, let's say a 45 year old couple places $5,650 per year in their HSA over a period of 20 years, they have $2,000 per year in qualified medical expenses, and they get a 12% return on their investments.  If they withdraw the $2,000 from their HSA each year, they'll have a net contribution of $3,450 per year into their account, and they'll have $248,581 in their account when they begin their retirement years.

If on the other hand they delay withdrawing that money, they will have $392,686 in their account at age 65.  If they choose they can withdraw the $40,000 to reimburse themselves tax-free for the medical expenses incurred during that 20 year period, and still have $352,686 in their account - over $100,000 more than if they had withdrawn the money each year.

Strategy #3: make the maximum allowable deposit to your HSA at the beginning of each year.  Even though you are allowed until April 15 of the following year to make deposits to your HSA, you should take advantage of the tax-free growth in your account by funding it as soon as possible.  The extra interest you can earn by contributing to your account on January 1 of each year rather than the next April 15 can amount to over $40,000 in a 20 year period, and over $100,000 in 30 years.

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How to Maximize Your HSA Contributions

Because catch-up contributions are allowed only for people age 55 and older, if one or both of you are over age 55 you should each establish your own HSA.  This will allow you to capitalize on the expanded HSA contribution limits for people in this age range by both making catch-up contributions.

Using Your HSA to Pay for Medical Expenses during Retirement

When you enroll in Medicare, you can use your account to pay Medicare premiums, deductibles, copays, and coinsurance under any part of Medicare.  If you have retiree health benefits through your former employer, you can also use your account to pay for your share of retiree medical insurance premiums.  The one expense you cannot use your account for is to purchase a Medicare supplemental insurance or "Medigap" policy.

Though Medicare will pay for the majority of health expenses during retirement, there many be expenses that Medicare will not cover.  Nursing home expenses, un-conventional treatments for terminal illnesses, and proactive health screenings are all examples of medical expenses that will not be paid for by Medicare, but that you can pay for from your HSA.

Long-term care is assistance with the activities of daily living, such as dressing, bathing, or feeding yourself.  It can be provided in your home, a retirement community, or a nursing home.  Long-term care expenses can be paid for using funds from your HSA, and long-term care insurance can even be paid for from the HSA up to the following maximum annual amounts:

• Age 40 or under: $260
   
• Age 41 to 50: $490
   
• Age 51 to 60: $980
   
• Age 61 to 70: $2,600
   
• Age 71 or over: $3,250

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