It was around 2am last night when the “dada, dada, dada” started coming from the room across the hall. Shortly after, it was followed by the high pitched cry that was far too common for a new parent. I knew the problem right away, my son was having a nightmare. Once again, the recurring nightmare that his favorite toy, Clifford the stuffed animal, was lost. We located Clifford, tucked in my son and a few minutes later he was sleeping soundly. If only our own nightmares could be solved so easily.
For my son, losing Clifford may keep him up at night, but for many of us the reasons are more complicated. I’m sure you don’t need it, but let me give you one more reason to be concerned when you lay down tonight. This article from Fidelity claims that a couple will spend over $260,000 just for healthcare in retirement. Now, that’s scary. Luckily, much like locating Clifford, there is a solution to your healthcare nightmare, and it is a health savings account (HSA). You may already know how important an HSA is for paying for healthcare in retirement but you may not know all of the ways to maximize your HSA. This post discusses making the most out of your HSA so that you have sufficient funds to pay for these potentially huge healthcare costs in retirement.
Max out your HSA contributions
There is no more tax efficient savings account than the HSA, and most people aren’t contributing enough. In 2018, a single individual can contribute $3,450 per year to an HSA and the limit is $6,900 if you have a family plan. If you are over the age of 55, you can contribute an extra $1,000 per year. These limits include both you and your employer contributions, if your employer does contribute as well. Sure, you probably know the importance of contributing to a 401(k), but how if I told you that the HSA is an even better savings account. The HSA offers a triple tax advantage; you get a tax deduction for making the contribution, the money grows tax free, and withdrawals (as long as used for healthcare costs) are also tax free. As I mention in this post, contributing at least 10% to your 401(k) is important, but before maxing out your 401(k) you need to max out the HSA first. You are going to have a lot of healthcare costs in retirement, you can’t put too much in your HSA, and even if you do, you can take penalty free withdrawals starting at age 65, for any reason.
Don’t use your HSA (at least not yet)
The first impulse most people have when they have a medical expense, is to take out the HSA card. I’m telling you to put away the HSA card, cut it up if you have to. Ideally, while you are working, you will use just normal savings to pay for healthcare costs and use the HSA for healthcare costs in retirement. There are two main benefits of utilizing this strategy. First, the HSA grows tax free, so the longer that you are able to invest and grow the HSA, the more advantageous it is. Second, this strategy allows you to have more savings when you need it the most, in retirement. In retirement, your income will be lower, and healthcare costs typically higher, so the extra savings is even more important. I realize that healthcare costs can be high during your working years as well, but if possible, try to not spend the HSA and leave it for retirement healthcare expenses. You won’t regret it.
Invest the HSA
If you aren’t investing the HSA, you are losing out on one if its most important features; tax free growth. Yet, I can’t tell you how many people just leave the money sitting in cash, not really earning anything. Many people do this because of the issue I discussed before, which is they are spending all of their HSA each year, so they really don’t have much to invest. Again, if you can avoid taking withdrawals, make sure that you are moving money over to the investment side and get that money growing for you. You will need to typically keep some of your HSA in cash which you will use if you do need to spend it prior to retirement. For the rest of the HSA, invest the funds and take full advantage of that tax free growth.
Contribute to your HSA in retirement
One of the biggest advantages of the HSA is that you can continue to make contributions in retirement, up until you turn on Medicare (typically age 65). In order to make HSA contributions in retirement you will have to have an HSA-eligible high deductible insurance policy. In retirement most of your tax deductions, like 401k and IRA contributions, are eliminated so the HSA is really the only tax advantage savings plan which you may have access. This strategy works best when you have after-tax savings (brokerage account, savings account, etc.). This is because you are converting an after-tax asset with no tax benefits to an HSA which allows the triple tax advantage as discussed earlier. If you don’t have after-tax savings to contribute to an HSA, you may still be able to utilize the next strategy.
Take advantage of the one-time IRA rollover to an HSA
Even if you don’t have after-tax savings, you can take advantage of the one time rollover rule from an IRA to an HSA. You can only do this one time and the amount of the rollover is capped at the yearly HSA contribution limit. Still, the tax advantage makes doing the one time rollover beneficial. You are converting an IRA which is taxed, to an HSA which has tax-free distributions when used for healthcare expenses. There are a couple limitations on doing the one-time IRA to HSA rollover though:
- You must still have an HSA-eligible high deductible health insurance plan and be able to make HSA contributions
- You must continue to have an HSA-eligible high deductible health insurance plan for 12 months after the IRA to HSA rollover
Even with the limitations, an IRA to HSA rollover makes sense if you don’t have after-tax savings to make an HSA contribution in retirement.
In all likelihood, healthcare will be your biggest expense in retirement. Thankfully, there is a solution. The HSA is the most tax friendly savings account out there and the goal should be to maximize your HSA for use in retirement. The goal for your HSA is to max it out each year, try not to use it before retirement, and make sure your HSA is fully invested. Even in retirement you may be able to continue to make contributions and continue to take a tax deduction. There are plenty of things that may keep you up at night; the stock market, having enough money in retirement, losing your son’s favorite stuffed animal. Maximize your HSA and sleep soundly that at least you have a plan for healthcare in retirement.