Top 5 Reasons to use a Health Savings Account | Lord Abbett
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Retirement Perspectives

While there are many reasons to consider an HSA, here are the top five, from our standpoint.

Read time: 5 minutes

Health Savings Accounts (HSAs) have quietly become a significant benefit for workers and a core component of a solid retirement income strategy. HSA account assets have climbed to $82.2 billion in over 30 million accounts, according to Devenir. The firm currently projects that the HSA market will exceed 36 million accounts by the end of 2023, with over $127 billion in assets.1

Why has it become so popular? An HSA is a tax-advantaged way to save money for out-of-pocket medical expenses like doctor visits, dental and vision care and prescriptions. The tax benefits mean that you get to keep more of your hard-earned money, plus you can use it now or save it to cover your health care costs when you are retired.

While there are many reasons to consider an HSA, here are the top five, from our standpoint.

 

With an HSA you hit a tax-saving triple

  • Tax deductible contributions
  • Tax derred growth, and
  • Tax-free distributions for qualified medical expenses

 

  1. Effective savings vehicle for costly retirement health care: Health care is not getting any cheaper and experts expect costs to continue to rise. According to Fidelity’s Heath Care Cost Estimate, a 65-year-old couple who retired in 2020 will need $295,000 to cover health care costs in their golden years—an 84% jump from the firm’s first projection of $160,000 in 2002. 2 The estimate assumes individuals do not have employer-provided retiree health care coverage but are covered under Medicare.
  2. The answer to the question of “How will I cover retiree health care costs? Enter the HSA – a unicorn in the world of tax advantaged accounts. Contributing to an HSA can help defray the cost of both unexpected out-of-pocket expenses in the future (i.e. deductibles, co-pays, out-of-pocket, non-covered services, etc.) on a tax-free basis.

  1. Triple Tax Free: Let us say that again. Triple tax free! Contributions to an HSA are not taxed. Funds grow in the HSA tax-deferred. And withdrawals for “qualified medical expenses” are also tax-free.

    An HSA is like a Roth IRA with distributions dedicated to certain medical expenses. But unlike a Roth, HSA contributions are federally tax deductible (Roth accounts are always funded with after-tax dollars). Due to this unique tax structure, a larger number of investors have been using HSAs to save for future medical expenses.

    Practice Tip: Although contributions are deductible on one's federal income tax, this is not always true for state income tax. A few states do not conform to federal legislation and don’t recognize HSAs, so contributions are not deductible. Check with a tax professional for details.

  1. You can invest it for growth: You can invest an HSA balance in mutual funds. Remember, the money you earn from investing is tax-free. And you can keep letting it grow and use it for health care expenses either now or in retirement. Employers typically offer a menu of investment choices to employees.

    Investing in both an HSA and a 401(k) (or IRA) gives you “twin powers” and synergy in your retirement accounts, with potential for growth. These vehicles complement each other in providing a path to prepare for a secure financial future, especially considering that as health care costs continue to increase, your retirement savings may be affected.

  1. You don’t lose what you don’t spend: Your HSA funds are not a case of “use it or lose it” (like Flexible Spending Accounts). Any money you don’t use at the end of the year rolls over to the next year. Your balance can keep growing.
  1. Portable: You can take it with you. It goes with you even if you get a new job with a different employer or leave the workforce.

How HSAs work

  1. Eligibility: HSAs are paired with a High Deductible Health Plan (HDHP), which typically offers employees lower premiums than a traditional health plan. To contribute to an HSA, you must be enrolled in an HDHP, not enrolled in any other health coverage (i.e. a spouse’s plan, unless that plan is an HSA-eligible plan), you cannot be claimed as a dependent on another person’s tax return, and most importantly, you cannot be enrolled in Medicare. For 2021 the HDHP must have an annual deductible of at least $1,400 for individual coverage and $2,800 for family coverage. Not all HDHPs plans are HSA eligible; if you are unsure check with your benefits department or health insurance carrier.

  2. Contribution limits: In 2021, the maximum contribution you can make to an HSA is $3,600 for single ($4,600 for those aged 55-plus) and $7,200 for family coverage ($8,200 aged 55-plus). Note the “base” contribution limits are indexed for inflation, whereas the age 55 catch-up limit is not. The contribution deadline is the employee’s tax-filing deadline, not including extensions, so you still have time to make a 2020 HSA contribution. For 2020, the contribution limits are $3,550 (single coverage) and $7,100 (family coverage), plus an additional $1,000 catch up for those individuals age 55 and older.

    Practice Tip: HSA account owner is required to file IRS Form 8889PDF Document (“Health Savings Accounts”) with their income tax return each year they make a contribution or take a distribution. This includes employer contributions. You must report all contributions to an HSA on the 8889 and file it along with your Form 1040.  Annual HSA contribution amounts are generally pro-rated for the number of months the individual is enrolled in an HDHP.

HSAs, unlike IRAs, are not subject to lifetime required minimum distributions, and also offer the flexibility to take a tax and penalty-free distribution in the current year for a previous year’s medical expense as long as the HSA was established prior to the expense being incurred.

On the other hand, nonqualified distributions (not for qualified medical expenses) are taxable and subject to a 20% penalty tax (as opposed to the10% penalty tax associated with most tax-advantaged accounts). When taken after age 65 (not 59½), however, the 20% penalty is waived (though nonqualified distributions over age 65 are still taxable). After age 65, a non-qualified HSA distribution is taxed in the same manner as a traditional IRA: funds are subject to income tax only.

  1. Rollovers: HSAs are owned and controlled by the employee, not the employer; therefore, you can roll over your HSA account to another HSA provider; tax-free. A rollover isn’t included in your income, isn’t deductible, and doesn’t reduce your contribution limit (in the year of the rollover). Other rollover rules include:
  • You can roll over amounts from a Medical Savings Account and other HSAs into an HSA.
  • Rollover contributions don’t need to be in cash.
  • Rollovers aren’t subject to annual contribution limits.
  • You must roll over the amount within 60 days after date of receipt.
  • You can make only one rollover contribution to an HSA during a one-year period.
  1. Beneficiaries: You must name a beneficiary, just as you would with an IRA or 401(k). And like retirement accounts, the individual you name inherits the HSA after your death. You can name anyone as beneficiary (spouse, non-spouse, estate, etc.). Special tax rules will apply for your beneficiaries; talk to a tax professional for details.

Practice Tip: Talk to your clients about the “significant opportunity of funding an HSA with an IRA”. While IRA assets generally can’t be rolled over or transferred to an HSA, there is, however, a one-time exception referred to as Qualified HSA Funding Distribution (QHFD). An individual once in his or her lifetime can transfer funds tax free from an IRA only (not a 401(k)) to his or her HSA—up to the contribution amount allowed for the year. The rollover amount cannot be more than the annual HSA contribution limit minus any contributions that are made for the year.

Key Takeaways

  • An HSA is a tax-advantaged way to save money for out-of-pocket medical expenses both now and in the future.
  • An HSA offers triple tax advantages: Contributions are tax deductible, funds are tax-deferred, and withdrawals for qualified medical expenses (including earnings) are tax-free.
  • Combining the “twin powers” of an HSA and a 401(k) or an IRA creates key retirement account synergies. These vehicles complement each other and are core components of a solid retirement income strategy.

 

1 Devenir Research: 2020 Year-End HSA Market Statistics & Trends Executive Summary

2020 Fidelity Retiree Health care Cost Estimate, Fidelity Investments

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, recommending to another party any transaction, arrangement, or other matter.

These materials do not purport to provide any legal, tax, or accounting advice.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

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