Health Savings Accounts - The Supercharged Retirement Plan

Question: Can I utilize funds accumulated in my Health Savings Account for living expenses during my retirement years?

Answer: Eligible individuals can make tax-deductible contributions to Health Savings Accounts (“HSAs”) which accumulate on a tax-deferred basis. Withdrawals from HSAs are not subject to income tax to the extent the funds are used for qualifying medical expenses of the account owner or his or her spouse or dependents. HSA funds not used for qualifying medical expenses are subject to income tax and if the HSA owner has not attained age 65 at the time of withdrawal, a 20% penalty tax.

To be eligible to contribute to an HSA, an individual must (i) be covered by a high-deductible health plan (“HDHP”), (ii) not be covered by a health plan which is not an HDHP and (iii) not be enrolled in Medicare. An HDHP must have deductibles in excess of certain amounts for individuals, $1,300 in 2016, and for families, $2,600 in 2016. For 2016, individuals with self-only coverage can contribute $3,350 to an HSA and individuals with family coverage can contribute $6,750. Those HSA account owners who have attained 55 are entitled to contribute an additional $1,000 per year.

One particularly beneficial feature of an HSA is that funds need not be withdrawn at a specific time nor by a specific date. So long as the HSA account owner can establish that HSA withdrawals are used for reimbursement of medical expenses incurred after the HSA was established, no tax is imposed on the withdrawals. Absent cash flow concerns, a meaningful tax benefit can be realized by retaining funds in an HSA, enabling earnings to compound on a tax-deferred basis.

In many respects, HSAs are a superior retirement vehicle to 401(k) plans, traditional IRAs and Roth IRAs. While tax deductions are permitted for contributions to 401(k) plans and traditional IRAs, distributions from these accounts are subject to income tax. Withdrawals of funds in 401(k) plans and traditional IRAs must commence by a specific date.  Distributions from Roth IRAs are not subject to income tax but contributions to Roth IRAs are not tax deductible. HSAs are funded by tax-deductible contributions, permit tax-free withdrawals and do not require distributions to begin at a specified time.

Qualifying medical expenses are those which are allowable as itemized deductions for tax purposes, thereby permitting tax-free withdrawals for routine medical expenses as well as vision care and dental expenses and other medical purposes. Considering that medical expenses constitute among the most significant of expenditures for many retirees, even the largest of HSA accounts will likely be exhausted during the HSA account owner’s lifetime. To the extent funds remain in an HSA at the time of the account owner’s death, the account owner’s surviving spouse can succeed to the deceased account owner’s HSA and enjoy the same tax and other benefits.

The mistake many HSA account owners make is regularly withdrawing HSA funds as and when medical expenses are incurred. If cash flow permits, a better tax result is achieved by having HSA funds remain intact and allowing earnings to compound on a tax-deferred basis recognizing that the withdrawal of HSA funds can be made at any time for medical expenses incurred after the HSA was established. If funds accumulated in an HSA exceed the medical expenses incurred after the HSA was established, at worst income taxes are incurred if distributions are postponed until the account owner attains age 65. In any case, your HSA, if properly used, can function like a retirement account providing additional income in retirement years.

 

The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions you want to be answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfnr.com.