How a Health Savings Account Can Double as a Retirement Plan
Courtney Francis, Tax Manager
Due to the increasing costs associated with retirement, it is important to know what options are available for saving. Most taxpayers are probably familiar with the immediate tax savings that come from contributing to a health savings account (HSA). Many may be unaware, however, of the long-term advantages.
Health savings accounts are best known as an employee benefit used in conjunction with a high deductible health plan, providing a tax favorable way to pay for qualified medical expenses. Each year the IRS sets annual HSA contribution limits for self-only and family coverage plans, along with respective annual deductibles that meet the definition of a high deductible health plan. See Revenue Procedure 2014-30 for the 2015 inflation adjusted amounts. An HSA provides a triple tax advantage by: (1) reducing taxable income; (2) providing tax-free growth; and (3) allowing tax-free distributions for qualified medical expenses. While these features are attractive, one must proceed with caution as the penalty for non-qualified withdrawals is 20%, plus the standard income tax that applies to taxable income.
So how does all of this relate to long-term and/or retirement savings? There is no distribution requirement with HSAs and the unused balance carries over from year to year. Depending on the amount used for medical expenses, a substantial portion of the contributions could roll over into subsequent years and accumulate over time. Moreover, HSA funds can be invested after reaching a certain threshold (typically $2,000), allowing the account to grow, similar to an IRA. Once the account holder reaches age 65, funds from the HSA can be withdrawn at any time without penalty. Withdrawals for non-medical expenses are taxed as income, similar to a traditional IRA, while withdrawals for qualified medical expenses remain tax free. Qualified medical expenses include premiums for Medicare Part D, long-term care insurance (subject to limitations), and health care continuation coverage. Therefore, once retirement age is reached, HSA funds can be withdrawn, tax-free, in order to meet rising medical costs and contribute to staying insured.
Despite rising costs in medical care and retirement living, it is possible for the HSA to have a balance remaining when the account holder dies. What happens upon the death of the account holder depends on who is named as the designated beneficiary. If the designated beneficiary is the account holder’s spouse, the account continues as an HSA and is transferred to the spouse. If anyone other than the spouse is the designated beneficiary, the account ceases to qualify as an HSA and the fair market value of the account is taxable to the beneficiary in the year of death. The amount used to pay qualified medical expenses for the decedent, if paid within one year after death, will reduce the amount taxable to the beneficiary. Finally, if no beneficiary is named or the account holder’s estate is the beneficiary, the value is included on his or her final income tax return. No reduction is allowed for qualified medical expenses in this instance.
We all have unique individual or family situations that influence our decisions. Understanding the options available can help us make the best decisions, and the ability of HSAs to serve both financial and healthcare needs may make them more attractive. If you are interested in learning more about HSAs, please contact your BNN tax advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.