A confluence of factors – longevity, inflation, a confusing healthcare landscape, and the limitations of Medicare – can have a significant effect on a person’s ability to afford their medical expenses in retirement. In fact, it’s a topic that concerns many Americans. A recent study by Fidelity found that a majority of respondents – 70% – feel unprepared to cover healthcare expenses in retirement. However, those who have health savings accounts (HSAs) feel more prepared (47%) compared to just 27% of people who don’t have an HSA.
If you are still working, an HSA is an excellent way to stockpile money to pay for healthcare costs in retirement. The same Fidelity study estimated that a 65-year-old couple retiring this year can expect to spend an average of $315,000 in healthcare and medical expenses in retirement, so it never hurts to start saving early. In 2022, individuals can contribute up to $3,650 for themselves or $7,300 for family coverage, and those aged 55 and older can make an additional $1,000 catch-up contribution.
You can only open an HSA if you have a qualifying high-deductible health plan. Ostensibly, having an HSA enables you to save pre-tax dollars to cover healthcare costs that your insurance doesn’t pay. Those who can afford to pay out-of-pocket for healthcare costs now, while contributing to their HSA, can create a sizeable nest egg for medical expenses in retirement. Here are some other key points to understand about HSAs.
You can invest the funds within your HSA.
HSAs work a bit like IRAs, in that the money you contribute can be invested. Another similarity between HSAs and IRAs is that they are both tax-advantaged accounts. HSAs offer an even greater after-tax result as they offer a triple tax advantage compared to a Traditional or Roth IRA. Let’s count the ways: First, contributions are pre-tax (if you contribute through payroll deduction) or tax deductible (if you contribute post-tax dollars). Second, the funds inside the HSA grow tax-free. Finally, HSA withdrawals are also tax-free when used to pay for qualified medical expenses.
HSAs have no “use it or lose it” provision, and they remain with you even if you change jobs.
Unlike a flexible savings account, which must be spent by the end of the year, HSA contributions stay with the owner. Moreover, if you move to another job, you can take your account with you.
You can also make a one-time rollover from your IRA to fund your HSA.
This is a tax-savvy move for individuals with large IRA balances who are approaching the age where they will have to take required minimum distributions.
You can withdraw funds from your HSA for non-medical expenses, but expect to pay ordinary income tax as well as a 20% penalty.
If you are 65 or older and use the money for a non-medical expense, you won’t face a penalty but will still be taxed at your ordinary income rate.
Once you go on Medicare, you can no longer contribute to an HSA.
However, you can withdraw money to use for qualified medical expenses.
That’s all fine and dandy for pre-retirees, but what about those already in retirement? As Savant’s tax director Kelli Peterson wrote last summer, the obvious answer is Medicare, which consists of four parts:
- Part A (Original Medicare) covers hospital care, most skilled nursing facilities, and hospice/home health services. If you previously paid more than 40 quarters of Medicare payroll tax while working, Part A is premium-free.
- Part B (Original Medicare) covers doctor visits, clinical lab services, outpatient and preventive care, screenings, surgical fees/supplies, and physical and occupational therapy. The premiums for Part B are based on your modified adjusted gross income (MAGI) reported on your tax return from two years ago.
- Part C (Medicare Advantage) combines parts A and B and can also include prescription drug coverage. The premiums are based on the type of plan you choose and what is covered by the plan.
- Part D (Prescription Drug Plan) covers your prescriptions. These premiums are also based on your MAGI as reported on your tax return from two years ago.
You may need a Medicare supplement to help cover the costs of unexpected medical events, or a “Medigap” policy that can help pay for any out-of-pocket costs not covered by the Medicare plans listed above (such as copayments, coinsurance, and deductibles).
Another option is to consider a life insurance policy with a long-term care benefit. These policies can be used for long-term care expenses and will pay a death benefit when the policyholder dies. The death benefit will decrease, however, if you use the policy to cover long-term care expenses.
Your financial advisor can discuss the advantages and disadvantages of each option and may be able to suggest other alternatives depending on your personal financial situation. As the Fidelity study shows, it’s never too early to start planning for this potentially significant cost in retirement.
This is intended for informational purposes only and should not be construed as personalized investment or financial advice. Please consult your investment and financial professional(s) regarding your unique situation.