Healthcare continues to be one of the most significant expenses you will incur during your retirement. A study by Fidelity shows the average couple will need $280,000 in today’s dollars for common medical expenses in retirement. If you pay an Income Related Monthly Adjustment Amount (IRMAA) for Medicare or incur long-term care, the amount needed can grow significantly.
You may ask why health care costs are a bigger concern now than when our parents retired. Here’s what we think:
To help individuals manage their health care costs, Congress passed a bill in 2003 setting up Health Savings Accounts, known in short as HSAs. We find HSAs very enticing because they have a triple tax advantage. Let me repeat—a triple tax advantage. This is as good as it gets.
- Pre-tax contributions
- Tax-deferred growth for the investments
- Tax-free withdrawals for Qualified Medical Expenses (QMEs)
Your retirement accounts only offer two tax advantages, not three. Take 401k plans as an example. 401k plans provide pre-tax contributions and tax-deferred growth but withdrawals are taxed. Roth IRAs grow tax-free and are withdrawn tax-free, but contributions are made after you’ve paid tax on those dollars. HSAs enjoy all three tax advantages.
We find it can be helpful to think about an HSA as another one of your retirement accounts, only specially designed to cover medical expenses. If you can afford to do so, here is a simple strategy.
In order for your withdrawals to be tax free, you’ll need to match them with Qualified Medical Expenses (QMEs) which are defined in 2017 IRS Publication 502, Medical and Dental Expenses.
Deductible QMEs are:
Similar to your retirement accounts, you need to name a beneficiary for your HSA account. The disposition of the account is based on the beneficiary designation.
Remember, a triple tax advantage is only available with an HSA account. If you don’t have an HSA and your health insurance is an eligible HDHP, we suggest you open an account. Name your beneficiaries. Fund your account to the maximum amount each year. Stop contributions when you are no longer eligible. Be careful when coordinating HSA contributions and Medicare. Moreover, remember to use your account in your later years. We hope this information gives you the knowledge to understand the rules and how to use them to help you.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.