Navigating Retirement With Your HSA

Clients need to understand this: The average person will need $180,000 for healthcare in retirement

by Kevin Robertson

As more Americans get closer to retirement, they have some important decisions to make about their healthcare. Along with housing, healthcare can be one of the greatest expenses in retirement. The average person needs to save $180,000 for healthcare expenses in retirement¹; however, an alarming 40% of Americans never save money specifically for future healthcare expenses.² This means vast numbers of Americans are entering retirement woefully unprepared for their future healthcare expenses.

Health Savings Accounts (HSAs) have proven to be the most powerful tool to save for healthcare expenses in retirement; however, contributions are currently limited to those enrolled in an HSA-qualified high-deductible health plan (HDHP). Additionally, people can no longer contribute to an HSA once they’ve enrolled in Medicare or Medicare Advantage—that’s nearly 60 million Americans who cannot contribute to an HSA3. Millions of Americans transition into Medicare every year, and hundreds of thousands of them have HSAs. With so many people entering or currently in retirement with an HSA balance, it’s critical they use the right strategies to maximize the impact of their HSA balance.

Funding your HSA from your IRA

Many people may not know that they can make a one-time, penalty- and tax-free rollover of money from their individual retirement account (IRA) to their HSA.

People age 55+ may want to review this option before going on Medicare and while they’re still on a high-deductible health plan. In fact, a strong argument can be made that everyone with an IRA balance may benefit from this move because of the financial benefits it affords. The primary benefit is that one is moving assets from a structure that will be taxed upon withdrawal to one that will potentially never be taxed, so the HSA offers a triple-tax benefit and gives more flexibility on when and how to use the funds. However, the 20% penalty would still apply if a person took money out of their HSA prior to age 65 for non-qualified distributions. This is a similar consequence if early distributions were taken from the IRA. Additional benefits of this rollover option are that HSAs don’t have required minimum distributions (RMDs) like an IRA, nor do withdrawals impact Medicare means testing.

The IRA rollover is counted as part of the IRS HSA annual contribution limit. Those who want to rollover from their IRAs should check their total contributions and consult their tax advisor to fully understand the tax implications and requirements of migrating from an IRA to an HSA. The 2020 IRS HSA limits are $3,550 for an individual and $7,100 for a family. The catch-up contribution limit for those over age 55 adds an additional $1,000. While these amounts may not be as large as a 401(k) contribution, with so many people without adequate healthcare savings, every available tax advantaged dollar helps cover the needs in retirement.

As a note, a person can only make one IRA to HSA rollover during their lifetime. Technically, they can roll over from either a traditional or a Roth IRA to an HSA. However, it’s more advantageous to roll over from a traditional IRA. That’s because withdrawals of contributions from a Roth IRA are already tax- and penalty-free at any time, and the person can withdraw earnings tax-free after age 59½.

Invest now and keep investing after retirement

Investing within an HSA continues to grow in popularity. In fact, now investments represent almost 20% of all HSA assets. Investing in the HSA is a great way to potentially grow HSA funds for a nest egg for retirement, while still keeping some funds available for current medical expenses. But investing isn’t just for the accumulation phase. Similar to other retirement accounts, accountholders may want to keep investing after retirement as a way to preserve capital. In other words, just because you can no longer contribute doesn’t mean that you should stop investing, nor does it mean that you should immediately start drawing down the balance.

Pre-retirees and retired individuals should talk to their financial advisor about the right amount of cash to keep on hand in their HSA for medical expenses that may occur early on, and they should discuss their needs so they can select the right asset allocation for their investments. Most retirees are conservative in their allocations, but that doesn’t mean their HSA funds need to be in all cash. For instance, a stable value fund may be an option to keep their HSA funds steady with inflation. Accountholders should look at their entire portfolio for retirement. Liquidity is also an important attribute to consider, but remember that retirees may want to pay for medical expenses with other assets and reimburse themselves later with HSA funds to avoid timing impacts of taking withdrawals from invested assets. This is also a prime reason to keep sufficient assets in the base cash account for more immediate needs.

Don’t spend too early in retirement

Historical data shows that retirees will likely have more medical expenses during their retirement than they have accumulated in HSA assets. People continue to live longer, sometimes for decades in retirement. Because of this, it’s important for retirees to consider when their need for their assets will be will be greatest; rather than spending right away, retirees may want to try stretching their HSA funds out so these funds can continue to grow, and they can take advantage of the triple-tax benefit longer.

Retirees should expect to pay Medicare premiums, co-pays, some drug prescriptions, and other expenses like glasses, hearing aids, and dental work that Medicare will not pay for. Medicare premiums and these additional expenses will likely increase as a person ages. Retirees may not want to use their HSA funds on Medicare premiums too early. If retirees spend too early, they may miss out on using the HSA when other funds have been spent, and they need it most.

Keep the receipts

Keeping all healthcare receipts indefinitely is always a smart strategy. By doing this, accountholders can pay for medical expenses now with other assets and then be reimbursed through their HSA at any time in the future. This includes keeping those receipts after the death of the HSA accountholder, as they may be important to the spouse or the family of the deceased accountholder. These impacts may be substantial and are often overlooked during the transition of assets after death.

If one married partner dies with funds in their HSA, the HSA passes to the surviving spouse and can be continued to be used as an HSA. Additionally, the surviving spouse can use receipts for unreimbursed medical expenses from the deceased partner against the HSA within the tax return year.

If the HSA owner dies without a surviving spouse, their beneficiary would inherit the HSA and the funds would be a taxable transfer. However, within that final tax return year, if there are receipts for unreimbursed medical expenses from the deceased HSA owner, the heir could claim those in the final tax return. For example, if an HSA owner died with $100,000 in their HSA, but had $30,000 in unreimbursed medical expenses, the beneficiary could receive the $30,000 tax free and only $70,000 would be taxable to the beneficiary. If the accountholder doesn’t designate a beneficiary, the money will be included in their estate and taxed on their final tax return.

Health Savings for Seniors Act
Many people transitioning into Medicare with an HSA are frustrated to learn they can no longer contribute to their HSA. This is especially discouraging for working seniors who may still be covered on their employer’s medical plan, regardless of Medicare integration as a primary or secondary payer. Medicare Part A enrollment automatically kicks in once a person begins drawing from Social Security, which one can do at age 65. This will effectively bar someone from making or receiving HSA contributions once Medicare coverage is in place.

Support for changing current laws, allowing those on Medicare to continue contributing to their Health Savings Account (HSA), and thus, radically changing the landscape of spending and saving in senior years, is gaining traction in Congress. To expand access to HSAs for those on Medicare, Reps. Ami Bera (D-CA) and Jason Smith (R-MO) introduced H.R. 3796, the Health Savings for Seniors Act. This bipartisan bill would allow anyone covered by Medicare (or Medicare Advantage) the ability to continue to contribute to an HSA, regardless of age or income.

What this means for seniors is that there would be no changes to Medicare, but seniors on Medicare could more effectively stretch their healthcare dollars further by being able to continue to contribute to an HSA. Even if used as an expense “pass-through,” this would instantly help Americans better afford their healthcare expenses in retirement.

It’s too soon to predict whether this bill will pass, but it does show an increased awareness in how HSAs have become a more important way for employees to prepare for retirement. If this potential change is something that you care about and wish to see implemented, the best action you can take is to contact your legislators and ask that they support this bill. You can reach your Senators or Representatives by phoning the U.S. Capitol/U.S. House Switchboard at 
(202) 224-3121 and ask to be forwarded to your appropriate legislators.

Summary

As HSAs have increased in use and balances continue to grow higher, people closer to retirement age have asked for more support from their employers and financial advisors on what actions to take with their HSAs. There are many strategies that pre-retirees may want to consider when it comes to their HSAs in order to be better prepared for medical expenses in retirement. It’s smart for everyone, in all stages of life, to take some time now to review their benefits. Those who fully fund their HSAs, invest, and make estimates for medical expenses in retirement are on a strong path to the retirement preparation process. Small tweaks leading up to and during retirement may add up to a huge cumulative impact. Being deliberate about planning and, more importantly, taking action, will have lasting effects to improve retirement readiness and peace of mind.

Employers can also help their employees better prepare for retirement by providing regular reminders about their benefits plans and access to a financial advisor who can provide additional education on retirement strategies.

1 HealthView Services 2018 Retirement Healthcare Costs Data Report.” HealthView Services. 9 May 2019. http://www.hvsfinancial.com/wp-content/uploads/2018/09/2018-Retirement-Health-Care-Costs-Data-Report.pdf
2 “HSA Bank Health and Wealth IndexSM.” HSA Bank. March 19, 2019. http://www.hsabank.com/hsabank/learning-center/index2019
32020 Kaiser Family Foundation, State Health Facts, https://www.kff.org/medicare/state-indicator/total-medicare-beneficiaries