3 healthy habits for health savings accounts

See 3 easy ways to make the most of your HSA—now and into your retirement.

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Key takeaways

  • HSAs offer a number of benefits: not only spending for the short term, but also saving for longer-term qualified medical expenses, including those in retirement.
  • Unlike health flexible spending accounts (FSAs), HSAs are not subject to the "use-it-or-lose-it" rule. Any unused funds may be used to pay for future qualified medical expenses.
  • Once you reach age 65, you can also use your HSA to pay for COBRA and certain Medicare premiums as well as long-term care insurance.

More and more employers are offering HSA-eligible health plans to their employees. These plans are also known as high-deductible health plans (HDHPs) and are paired with health savings accounts (HSAs). If your company offers this option and you are not taking advantage of it, you may be missing an opportunity, as HSAs can play a valuable role in your financial wellness.

In the past, you may have heard that HSAs were a convenient way to pay for out-of-pocket costs, such as doctor visits or prescriptions at your local pharmacy. But did you know that HSAs can be used in a variety of ways to help manage other current qualified medical expenses—as well as for future qualified medical expenses, even after you retire?

HSAs: the basics

HSAs are individual accounts that work in conjunction with an HSA-eligible health plan to allow employees to cover qualified medical expenses. If you put money in an HSA and use that money to pay for a doctor visit or another qualified medical expense any time now or in the future, you'll never pay federal taxes on that money. And although state taxation may vary, most states follow the federal tax law.

What's more, unlike health flexible spending accounts (FSAs), HSAs are not subject to the "use-it-or-lose-it" rule. Funds remain in your account from year to year, and any unused funds may be used to pay for future qualified medical expenses.

The IRS maximum annual contribution limit for HSAs in 2018 is $3,450 for those individuals electing single coverage under an HDHP, and $6,900 for those electing family coverage. Individuals aged 55 and older in the calendar year may contribute an additional $1,000 (this applies to both single and family HDHP coverage). Family coverage includes any level of coverage other than self-only coverage, if offered by the employer.

You can use your HSA to pay for some or all of your qualified medical expenses each year and let the rest of the money in your HSA potentially grow for use in the future, including in retirement. Or, if you have the cash to pay your medical costs out of pocket, you can let your entire HSA grow tax free for future qualified medical expenses.1

3 healthy HSA habits

Consider how these 3 "healthy habits" can help you get the most value from your HSA, both now and in the future:

1. Cover anticipated out-of-pocket health care costs

Each year, during annual enrollment, you have the opportunity to make health care choices that serve the needs of you and your family for the coming year. You may be wary of enrolling in an HDHP because you are concerned about potential out-of-pocket costs. You may worry, "What happens if I get really sick or have a catastrophic accident? Where will I get the money to pay the higher deductible?"

These are valid considerations. To start with, you should factor in the deductible and any out-of-pocket costs. But what you may not realize is that you may be paying more than $2,000 every year in premiums for a "lower-deductible" plan—such as a traditional preferred provider organization [PPO] plan—whether you need services under the plan or not.

A "worst-case scenario" is typically going to occur only for a small number of people, and HDHPs generally provide generous coverage above the higher deductible, including an out-of-pocket maximum for protection. What's more, most preventive care and screenings are typically covered 100% by your insurance, including HDHPs.

Generally, those who choose a traditional health plan option may be paying higher premiums, while those who elect an HDHP generally pay a lower premium for health coverage and can direct those premium savings to their HSA to help cover any "worst-case" expenses.

Consider contributing enough into your HSA so that you have enough cash on hand to cover anticipated or unanticipated out-of-pocket qualified medical expenses for the year. If you save an amount equal to the in-network deductible for your plan, you may be better prepared for an unexpected trip to the emergency room or an unforeseen health issue in the coming year.

Also, while you cannot be enrolled in a general-purpose FSA if you elect an HDHP, more employers are offering HDHPs with the option to enroll in an HSA-eligible FSA—meaning you could set aside up to $2,600 in a post-deductible or limited-purpose FSA2 for this year's qualified medical expenses to pay for dental and vision expenses. However, your employer sets the maximum level allowed, which could be less than the $2,600 noted here, and unlike an HSA, the amount you set aside in a FSA will typically face use-it-or-lose-it rules each year.

2. Take advantage of available employer contributions

If your company supports your efforts to save with an employer contribution to your HSA, you're in good company. In 2016, 33% of all HSA dollars contributed to an HSA account came from an employer. The average employer contribution was $719.3

Combined with your own contributions, the contributions from your employer can go a long way to meeting any anticipated qualified medical expenses. While employers may have different rules and timing for their contributions, a common approach is for employers to deposit their full annual contribution into your account at the beginning of the year or as soon as you enroll in the HSA-eligible health plan and open your HSA.

3. Save and invest for future qualified medical expenses

Most financial professionals suggest that most individuals can benefit from tax-advantaged vehicles such as workplace savings plans and HSAs. While individual tax situations will vary, the triple tax advantages offered by HSAs merit a closer look. Generally, an HDHP with an HSA enables you to set aside pretax dollars through payroll deductions. An HSA can also be funded with after-tax dollars, which the individual then takes as a tax deduction on his or her personal taxes. These contributions can accumulate tax free and can be withdrawn tax free to pay for current and future qualified medical expenses, including those in retirement.4 An HSA balance can remain in your account from year to year, and you can take it with you should you switch employers or retire.

For example, let's say you have family coverage in an HSA-eligible health plan. You save $3,000 in your HSA for future use and you plan to spend $2,000 on eligible out-of-pocket health care expenses this year (e.g., co-pays, prescription drugs) without dipping into your HSA. If you want to consider a strategy that can provide additional tax advantages, increase your pretax HSA contributions to $5,000. Then spend $2,000 tax-free directly from your HSA on your out-of-pocket expenses. You could use this tax savings (in this example, potentially $500 that would have otherwise been withheld from your paycheck) to save more for retirement.

For many Americans, health care is likely to be among their largest expenses in retirement. A 65-year-old couple retiring in 2017 is estimated to need $275,000 to cover medical expenses throughout their retirement.5 Fortunately, employees who have access to an HSA-eligible health plan through their employer may have the option of saving and investing in an HSA. Investing for retirement is a priority for most Americans, and investing in a tax-advantaged HSA to help pay for current or future qualified medical expenses is becoming just as important.

Tip: Consider contributing the maximum that you can afford to your HSA, up to your maximum annual contribution limit. Think about ways you can stretch your budget to put aside a few more dollars to pay for health care expenses this year and in the future. You should also consider investing the portion of the HSA that you are saving for the future in an asset mix in line with your longer-term savings goals.

4 ways to use your HSA in retirement

You can always use your HSA to pay for qualified medical expenses like vision and dental care, hearing aids and nursing services. Once you retire, there are additional ways you can use the money6:

1. Help bridge to Medicare

If you retired prior to age 65, you may still need health care coverage to help you bridge the gap to Medicare eligibility at 65. Generally, HSAs cannot be used to pay private health insurance premiums, but there are two exceptions: paying for health care coverage purchased through an employer-sponsored plan under COBRA, and paying premiums while receiving unemployment compensation. This is true at any age, but may be helpful if you lose your job or decide to stop working before turning 65.

2. Cover Medicare premiumsv

You can use your HSA to pay certain Medicare expenses, including premiums for Part B and Part D prescription-drug coverage, but not supplemental (Medigap) policy premiums. For retirees over age 65 who have employer-sponsored health coverage, an HSA can be used to pay your share of those costs as well.

3. Long-term care expenses

Your HSA can be used to cover part of the cost for a "tax-qualified" long-term care insurance policy.7 You can do this at any age, but the amount you can use increases as you get older.

4. Pay everyday expenses

After age 65, there is no penalty if you use HSA money for anything other than health care. But you will have to pay income tax, similar to pretax withdrawals from your 401(k).

Summary

HSAs offer a number of benefits: not only spending for the short term, but also saving for longer-term qualified medical expenses, including those in retirement. The healthy habits outlined here can help you better understand how to take advantage of this growing health care savings opportunity.

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1. For more information on how the Internal Revenue Service defines "qualified medical expenses," read IRS Publication 502: Medical and Dental Expenses and IRS Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans.
2. Limited-purpose FSAs may be used to pay for eligible dental and vision care expenses.
3. 2017 Mid-Year Devenir HSA Market Survey.
4. With respect to federal taxation only. Contributions, investment earnings, and distributions may or may not be subject to state taxation. Please consult with your tax advisor regarding your specific situation.
5. Estimate based on a hypothetical couple retiring in 2017, 65 years old, with life expectancies that align with Society of Actuaries' RP-2014 Healthy Annuitant rates with Mortality Improvements Scale MP-2016. Estimates are calculated for "average" retirees, but may be more or less depending on actual health status, area of residence, and longevity. Estimate is net of taxes. The Fidelity Retiree Health Care Costs Estimate assumes individuals do not have employer-provided retiree health care coverage, but do qualify for the federal government's insurance program, Original Medicare. The calculation takes into account cost-sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B (inpatient and outpatient medical insurance). It also considers Medicare Part D (prescription drug coverage) premiums and out-of-pocket costs, as well as certain services excluded by Original Medicare. The estimate does not include other health-related expenses, such as over-the-counter medications, most dental services, and long-term care. Life expectancies based on research and analysis by Fidelity Investments Benefits Consulting group and data from the Society of Actuaries, 2014.
6. IRS Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans
7. IRS Publication 502: Medical and Dental Expenses
Keep in mind that investing involves risk. The value of your investments will fluctuate over time, and you may gain or lose money.
The information provided is general in nature and is not intended, nor should it be construed as, legal or tax advice. Since the administration of an HSA is a taxpayer (your) responsibility, you are also encouraged to review information available from the Internal Revenue Service (IRS) for taxpayers, which can be found on the IRS Web site at irs.gov. You can find IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and IRS Publication 502, Medical and Dental Expenses, online or you can call the IRS to request a copy of each at 800-829-3676.
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