One of the biggest challenges that your clients face when preparing for retirement is making sure they have enough savings to cover their future health care costs. For most Americans, this is one of the biggest expenses they'll face in their golden years: The average 65-year-old couple that retired in 2022 would need $315,000 to cover their health care costs in retirement, according to an analysis by Fidelity.
One important tool your clients may be able to use to help cover those costs is a health savings account (HSA). These accounts have become much more popular in recent years, as high-deductible health plans have become more common. There were more than 11 million HSAs with nearly $33 billion in assets at the end of 2020, according to the Employee Benefit Research Institute, but many of those accountholders are not making the most of these accounts.
Here's what financial advisors and clients need to know about making the most of these tax-advantaged accounts.
What is a health savings account (HSA)?
An HSA is an account available to consumers with a high-deductible health plan (HDHP) as long as they don't have any other health insurance coverage (including Medicare) and are not claimed as a dependent on anyone else's tax returns. (In 2023, HDHPs must have deductibles of at least $1,500 per year for an individual or $3,000 per year for a family.)
HSAs are the most tax-favored accounts available under the tax code. HSA assets go into the accounts before income taxes and grow tax-free, and withdrawals are also tax-free as long as they're used for qualified medical expenses. They are not subject to required minimum distributions.
Qualified medical expenses include a wide range of out-of-pocket health-related costs, including Medicare and long-term care insurance premiums, co-payments and deductibles for visits, and dental or eye care — even items like sunscreen and tampons. (Funds withdrawn for non-medical expenses before age 65 are subject to income tax as well as a 20% early withdrawal penalty.)
Many people get their HSAs through their employer and make HSA contributions via payroll deductions; the money in the account belongs to the owner. It rolls over year to year (unlike flexible spending account funds, which are "use it or lose it"), and the owner retains access to the funds after they leave their job.
While you can use the funds to cover current medical expenses, you can also let the money grow and use it to cover such costs in the future.
How much can you contribute to an HSA?
In 2023, you can contribute up to $3,850 for an individual and up to $7,750 for a family in an HSA, including both employee and employer contributions. Those limits are in addition to 401(k) or other retirement account contributions that an individual might make throughout the year.
Like an IRA, you can make contributions to an HSA for the previous tax year until the tax deadline of the next calendar year. That means that you can make a 2022 HSA contribution (up to $3,650 for individuals and $7,300 for families) until April 18, 2023. HSA contributions for tax year 2023 will be due on April 15, 2024.
Can you invest HSA money?
Yes, but the HSA administrator sets the rules for each account. Many custodians have a minimum account balance, typically around $1,000, required before you can start investing, and some only allow accountholders to keep their funds in cash or cash equivalents.
When invested, HSA funds can essentially become an additional spending account in retirement that clients can tap into along with other retirement funding sources such as a Roth IRA or Social Security.
However, fewer than 30% of employers position HSAs to employees as retirement savings vehicles, according to the Plan Sponsor Council of America. As a result, the vast majority of HSA accountholders (more than 90%, according to EBRI) do not invest their HSA funds.
What are the benefits of HSA investing?
There are many benefits to investing HSA funds. For account holders who aren't planning on using the money until retirement, keeping the entire account in cash means that it could lose value over time due to inflation.
