Use your Health Savings Accounts as a Retirement Tool

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By Dawson, Smith, Purvis, & Bassett P.A.

As you know, Health Savings Accounts (HSAs) are tax preferred accounts that allow tax deductible contributions to grow tax-free. In addition, distributions used for qualified medical expenses are excluded from income. Distributions not used for qualified medical expenses are generally subject to tax and a 20% penalty. Account holders enjoy the immediate tax benefits of deductible contributions but often overlook the tax-free growth of an HSA by withdrawing contributions to pay for current medical expenses. Harnessing the tax-free growth of HSAs by paying medical expenses from other sources is yet another retirement planning opportunity.

HSAs are governed in much the same way as an IRA. Contributions can be invested in a variety of investment vehicles. Many plans offer various mutual funds from which to choose. Investment strategies range from conservative to aggressive. Investing in these funds allows the account holder to accumulate a pool of funds on a tax-free basis.

HSAs use in Retirement

Funding post-retirement medical costs is often a concern. Insurance coverage is costly and as we all know, we use medical resources more as we age. Having a pool of funds available to help pay these costs can provide a significant safety net. For example, if at age 50 a married physician starts contributing $6,450 for 15 years and the fund earns 7% per year, the account would grow to $162,000; $65,332 of the account is a result of tax-free investment returns. Of course investments carry risks and results will vary. There is no guarantee of investment performance.

Insurance premiums are generally not a qualified withdrawal. However, after the Medicare age of eligibility has been met, an HSA can be used to pay all Medicare premiums as well as an employee’s share of employer provided health insurance, including retiree insurance.

In addition, once a beneficiary attains the age of Medicare eligibility, currently 65, distributions not used for medical expenses are no longer subject to the 20% penalty, resulting in your HSA essentially becoming a traditional IRA.

Keep in mind that once an individual enrolls in Medicare, they are no longer eligible to make HSA contributions.

HSAs after Death

At death, all assets of an HSA become the property of the account’s named beneficiary. If the HSA passes to a surviving spouse, there is essentially no change to the account. It continues as an HSA and all distributions used to pay for qualified medical expenses are still tax-free.

If the named beneficiary is someone other than a surviving spouse, the account ceases to be an HSA and it is treated as a distribution equal to the value of the account’s assets as of the date of death. The total distribution is included in the recipient’s taxable income, although the recipient can exclude from taxable income medical expenses paid on behalf of the decedent within one year of the date of death.

Conclusion

Most participants contribute to their HSAs to obtain the immediate tax break. However, the long-term benefit of letting the account grow tax free is often overlooked. The sooner you start maximizing the contribution and not withdrawing from the account, the greater returns you will hopefully attain.

We look at a variety of methods to reduce taxes and enhance retirement income. Maximizing 401(k) deferrals and funding ROTH and traditional IRAs are the traditional retirement planning tools. Maximizing the benefits of your HSA is another way to reduce current taxes and create wealth.

If you have any questions or would like additional information, please contact Dawson, Smith, Purvis and Bassett, P.A., at dspb@dspbcpa.com or 207-874-0355.

In accordance with Internal Revenue Service Circular 230, we hereby advise you that if this communication or any attachment hereto contains any tax advice, such tax advice was not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service.