Medical expenses will be growing in retirement. Medicare is not an end all and will not cover all our health-related costs. Health savings accounts (HSA) help offer a creative solution to help meet this gap.
To gain the maximum benefit of an HSA account in retirement, we need to rethink how we use our HSA. Instead of funding and immediately using the account to pay for current medical expenses, view the account as an additional retirement savings vehicle.
When you think about it, part of our total retirement savings will help us pay for our medical expenses in retirement. In fact, some experts anticipate that a significant percentage of our retirement costs will go toward healthcare costs. How much? Some anticipate the cost of healthcare while retired will cost $350,000 in today's dollars.
A savvy strategy is to fund the HSA account as early as possible and delay withdrawals to pay for medical costs until retirement using other resources today to pay for out of pocket medical expenses. This allows the account to grow and become a designated resource for paying medical expenses in retirement.
Besides, we are rewarded with a triple tax benefit; a tax deduction today for the contribution to the HSA account, tax free withdrawals of contributions, and tax-free withdrawals of earnings. By using the account today to fund current medical expenses, we lose the opportunity for the funds to grow and more importantly the potential for larger tax-free withdrawals in retirement.
With an HSA, the account owner can access the funds anytime tax free and penalty free to help pay for qualified medical expenses. This would include paying costs for dependents and spouses.
At age 65, distributions from an HSA to pay for expenses which are not qualified medical expenses are then free of the 20% penalty but would be taxable.
While an HSA account offers some very nice tax benefits and can be an ideal savings vehicle for retirement medical expenses, individual circumstances will help determine the most appropriate strategy for using the HSA in context of your overall financial picture.