Health Savings Accounts are a great way to start a second account for retirement. Anyone with a high-deductible health insurance plan that qualifies can open one of these tax-advantaged accounts. They have been around since January 2004, but were not available before then. Once you open an HSA account, you can put tax-deductible contributions into it, and it will grow tax-free like an IRA. You can take out tax-free money at any time to pay for medical costs.
Most people don't retire before age 65 because they don't have health insurance, and by the time they turn 65, many Americans are not at all ready for the medical costs they'll have to pay when they do retire. One of the most important long-term reasons to open an HSA is to save money for medical costs you might have in retirement.
According to Fidelity Investments, the average couple who retires in 2006 will need $190,000 to pay for medical costs during their retirement. This is based on the idea that the husband will live for 15 years and the wife will live for 20 years.
HSAs are without a doubt the best way to save money for retirement to pay for medical costs. You shouldn't put any money into your traditional IRA, 401(k), or any other savings account until you've put as much as you can into your HSA. This is because you can only take money out of a health savings account tax-free to pay for medical costs. You can take these payments whenever you want, before or after age 65.
Your IRA limits of $3,000 per year or $3,600 if you're over 55 won't change if you put money into an HSA. It's just another way to save for retirement without having to pay taxes right away. If you use the money to pay for medical expenses, you don't have to pay taxes on the money you take out.
For healthy early retirees who don't have Medicare coverage yet, a health savings account can be a good way to save money on health insurance costs while they wait. With an HSA plan, a person can save more the older they are. HSAs are by far the most affordable option for many people in their 50s and 60s who are not yet eligible for Medicare.
Any money you put into your health savings account is 100% tax-deductible, and the money in the account grows tax-free, just like an IRA. For 2006, the most a single person can put into their 401(k) is either their deductible or $2,700. In other words, if your deductible is $3,000, you can only contribute up to $2,700; if it's $2,000, that's the most you can give. For a family, the maximum is either $5,450 or the deductible, whichever is less.
If you are 55 or older, you can make a "catch-up" contribution of an extra $700 in 2006, $800 in 2007, $900 in 2008, and $1,000 from 2009 on. The limit on contributions is tied to the Consumer Price Index (CPI), so it will go up each year by the same amount as inflation.
How much you save in your HSA will depend on how much you put in each year, how many years you put money in, how much your investments earn, and how long you wait before you take money out. If you put money into your HSA every month and are lucky enough to be healthy and not need a lot of medical care, you can build up a lot of money in your account.
Accounts for health savings are self-directed, which means that you have almost full control over where your money is invested. There are a lot of banks that can help you manage your HSA. Some only offer savings accounts, while others offer mutual funds or access to a full-service brokerage where you can invest your money in stocks, bonds, mutual funds, or any number of other investment vehicles.
One of the best things about HSAs and other retirement accounts is that the money can grow without being taxed every year. This can increase your return by a lot. For example, if your tax rate is 33%, you would need a 15% return on a taxable investment to match a 10% return on a tax-deferred investment.
As another example, if you are in the 33% tax bracket and invest $5,450 each year in a taxable investment that gives you a 15% return, you will have $312,149 after 20 years. If you put that same amount of money into an HSA, you would have $558,317, which is more than $240,000 more.
Only people 55 and older can make catch-up contributions, so if one or both of you are under 55, you should open your HSA in the name of the older spouse. This will let you make the most of the higher HSA contribution limits for people your age, so you can put the most money into your HSA. When that person turns 65 and can no longer make contributions to their HSA, you can open a new account in the name of the younger spouse.
Strategies to help your HSA grow as much as possible
If you want your HSA to grow as much as possible so you can save more money for retirement, there are three important things you should do.
Strategy 1: Put your money in mutual funds or other investments that have the potential to grow. This is riskier than putting your money in an FDIC-insured savings account, but it is the only way to take full advantage of an HSA's tax-deferred growth feature.
Plan #2: Put off taking money out of your account as long as you can. Even though you can take tax-free money out of your HSA at any time to pay for qualified medical expenses, you can also leave the money in your HSA and let it grow tax-free. As long as you keep your receipts, you can take money out of your account tax-free to pay for medical expenses you paid for today at any time in the future as long as you have your receipts.
As an example, let's say a 45-year-old couple puts $5,450 into their HSA every year for 20 years, has $2,000 in qualified medical expenses every year, and gets a 12% return on their investments. If they take the $2,000 out of their HSA every year, they will put a net of $3,450 into their account each year. By the time they retire, they will have $248,581 in their account.
If, on the other hand, they wait until they are 65 to take that money out, they will have $392,686 in their account. If they want, they can take out the $40,000 to pay for their medical bills over the last 20 years without paying taxes on the money. If they do this, they will still have $352,686 in their account, which is over $100,000 more than if they had taken out the money each year.
Strategy #3: Put the most money you can into your HSA at the start of every year. Even though you have until April 15 of the following year to put money into your HSA, you should do it as soon as possible to take advantage of the tax-free growth in your account. If you put money into your account on January 1 each year instead of April 15, you can earn more interest. This extra interest can add up to over $40,000 in 20 years and over $100,000 in 30 years.
Using your HSA to pay for medical costs while you're retired
When you sign up for Medicare, you can use your account to pay any Medicare premiums, deductibles, copays, or coinsurance. If your former employer offers retiree health benefits, you can also use your account to pay your share of the premiums for retiree health insurance. You can't use your account to pay for a "Medigap" policy, which is extra insurance on top of Medicare.
Medicare will pay for most of your health care costs when you retire, but there may be some costs that Medicare won't cover. Some medical costs that Medicare won't cover, but that you can pay for with your HSA, include nursing home costs, non-traditional treatments for terminal illnesses, and preventive health screenings.
Long-term care is getting help with things like getting dressed, taking a bath, or feeding yourself. It can be given in your home, in a community for older people, or in a nursing home. You can pay for long-term care costs with money from your HSA. You can also pay for long-term care insurance with money from your HSA, up to the following maximum annual amounts:
- Age 40 or under: $260
- Age 41 to 50: $490
- Age 51 to 60: $980
- Age 61 to 70: $2,600
- Age 71 or over: $3,250
To open a health savings account, you must first have a high-deductible health insurance plan that works with HSAs. Compare two or more HSA plans side by side to figure out which one is the best deal for your needs. Once you have a health insurance plan with a high deductible, you can open a Health Savings Account at the bank of your choice.
