A declared but often overlooked purpose of health savings accounts (HSAs) encourages Americans to save for their health expenses in retirement. Although HSAs have many attractive features, the road to a successful use of these accounts for a more secure retirement presents obstacles, even to well-informed persons eager for the journey. These obstacles are usually manageable.
Less manageable, however, may be the window of opportunity for eligible persons to establish these tax-preferred accounts. The Democratic leadership in the White House and Congress may eventually limit that opportunity, especially if such accounts are judged incompatible with the direction of any health care reform legislation that may pass. Nevertheless, even restrictive legislation is likely to allow existing HSAs to continue and won’t become effective until sometime in the future.
Consequently, now is a good time for HSA eligible persons and their advisers to take a fresh look at the role such accounts may play in a secure retirement by reviewing their attractive features and challenges.
Attractive Features
Individuals and families are eligible to establish an HSA either independent of or through employment.
HSA contributions are deductible for purposes of federal income tax for persons with or without earned income and/or by those who do not itemize deductions. When established through employment, an employer’s HSA contributions, which may be made through a cafeteria plan, are also not taxed and are owned by the employee. The account and any funds in it remain with the employee account owner when the employment relationship ends. Unused funds roll over year to year with no accumulation limit and without affecting the contribution allowed in a current year. Account holders may invest HSA funds across a wide range of options with no tax on account growth in much the same way as funds in individual retirement accounts (IRAs).
Distributions taken to pay for qualified medical expenses are tax-free. These qualified expenses are the same as those allowed when itemizing Schedule A medical and dental expenses and include Medicare premiums as well as qualified long-term care insurance premiums. Distributions may also be used to pay the medical expenses of a spouse and dependents, even when such persons are not covered under the account holder’s health plan, just as long as the expenses are not paid by other sources of insurance. Distributions for any other purpose, if taken after age 65, are like other retirement plan distributions: they are without penalty, but become taxable when taken.
Moreover, to encourage the use of HSAs for health care expenses in retirement, individuals aged 55 and older may make an additional “catch-up” contribution of $1,000 annually. While combined contributions may not exceed the allowed family amount in total, a husband and wife may each make a catch-up contribution if both are covered under the same qualified high-deductible health plan and have separate HSAs. Other persons, such as relatives, may contribute to someone else’s HSA without compromising the deductibility of the contribution amount from the recipient’s taxable income.
Challenges
Eligibility and financial management encompass areas of broad challenges to the use of HSAs for retirement.
Eligibility challenges relate to coverage under a qualified high-deductible health plan (HDHP) that a person must have to open an HSA and/or continue contributions to it. Some persons such as independent professionals often have greater discretion over their health plans and can more readily select and maintain a qualified HDHP. Most other persons and their families obtain their health coverage as an employee benefit and realistically have an opportunity to open an HSA only if the employer offers an HDHP. Subsequent employers must also offer an HDHP, if a person’s HSA contributions are to continue.
Even a person otherwise eligible for HSA participation is disqualified if that person is covered by a health plan, even a spouse’s health plan, which is not an HDHP. Disqualification also occurs if health care expenses are payable from other funding mechanisms such as a typical health flexible spending account (FSA) or health reimbursement arrangement (HRA).
Financial management challenges also occur in several ways. Foremost is the built-in tension between the use of HSAs to pay for current health expenses and to fund these expenses in retirement. Persons of means can more easily fund an HSA for retirement while using current income to pay expenses left uncovered by the HDHP. Most people, however, have limited resources and personal and family financial priorities can constrain contributions to an HSA as a retirement fund. Almost everyone remains subject to the unplanned intervention of extraordinary health expenses that can exhaust HSA balances including any amounts accumulated expressly for retirement. Nevertheless, many Americans in the “golden decade” before age 65 with family financial obligations largely satisfied, incomes peaking, and health care needs still moderate should find themselves in a position to maximize retirement funding including contributions to an existing HSA. Early retirement by persons in this age cohort may allow them a first-time opportunity for HDHP coverage that would enable them to open an HSA and contribute to it until they enroll in Medicare.
The financial management challenge for still others may be that the current limits restrict them from making as great an HSA contribution for retirement as they would like. Previous legislation addressed this issue to a great extent by allowing contributions up to the HDHP’s out-of-pocket maximum amount, thereby nearly doubling the previously allowed maximum annual contribution.
Desirable Enhancements
Despite significant Democratic opposition, advocates desire further enhancements to encourage the broader use of HSA accounts. Suggestions for such enhancements include:
These enhancements are highly unlikely under the current Congress and administration. In the meantime, current information on the complex subject of HSAs, including their use for retirement savings, is available by visiting the Treasury Department’s Web site at www.treas.gov/offices/public-affairs/hsa.
This article is based in part on material from the textbook Health and Long-Term Care Financing for Seniors coauthored by Burton T. (Tom) Beam, Jr., Nancy P. Morith, and Thomas P. O’Hare of The American College. The textbook is required reading for a course leading to The College’s Chartered Adviser Senior Living (CASL) designation.