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Using Your Health Savings Account to Build Retirement Savings
By Wiley Long
Health
Savings Accounts are an excellent way to build a second retirement account.
These tax-favored accounts, which have only been available since January of 2004,
can be opened by anyone with a qualifying high-deductible health insurance plan.
Once you open an HSA account, you can place tax-deductible contributions into
it, which grow tax-deferred like an IRA. You may withdraw money tax-free to pay
for medical expenses at any time.
The biggest reason more people don't retire before age 65 is lack of health insurance,
and many Americans reach age 65 woefully unprepared for the medical expenses they'll
face once they do retire. One of the most important long-term reasons for establishing
an HSA is to build up some
money for medical expenses incurred during retirement.
Fidelity Investments reports
that the average couple retiring in 2006 will need $190,000 to cover medical
expenses during retirement. This assumes life expectancies of 15 years for the
husband and 20 years for the wife.
HSAs are, without exception,
the best way to build up money to pay for medical expenses during retirement.
You should not contribute any money to your traditional IRA, 401 (k), or any
other savings account until you have maximized your contribution to your HSA.
This is because only health savings accounts allow you to make withdrawals tax-free
to pay for medical expenses. You can take these distributions anytime before
or after age 65.
Your HSA contributions won't
affect your IRA limits -- $3,000 per year or $3,600 for those over 55. It's
just another tax-deferred way to save for retirement, with the added advantage
being that you can withdraw funds tax-free if they are used to pay for medical
expenses.
For early retirees who are
healthy, a health-savings account can also be a smart option to help lower their
health insurance costs while they wait for their Medicare coverage. The older
someone is, the more they can save with an HSA plan. For many people in their
50's and 60's who are not yet eligible for Medicare, HSAs are by far the most
affordable option.
Any money you deposit in
your health savings account is 100% tax-deductible, and the money in the account
grows tax-deferred like an IRA. For 2006, the maximum contribution for a single
person is the lesser amount of your deductible or $2,700. In other words, if
your deductible is $3,000, you can contribute a maximum of $2,700; if your deductible
is $2,000, then that is the maximum. For families, maximum is the lesser of
$5,450 or the deductible.
If you're 55 and older,
you can put in an extra $700 catch-up contribution in 2006, $800 in 2007, $900
in 2008, and an additional $1,000 from 2009 onward. The contribution limit is
indexed to the Consumer Price Index (CPI), so it will increase at the rate of
inflation each year.
How much you accumulate
in your HSA will depend on how much you contribute each year, the number of
years you contribute, the investment return you get, and how long you go before
withdrawing money from the account. If you regularly fund your HSA, and are
fortunate enough to be healthy and not use a lot of medical care, a substantial
amount of wealth can build up in your account.
Health savings accounts
are self-directed, meaning that you have almost total control over where you
invest your funds. There are numerous banks that can act as your HSA administrator.
Some offer only savings accounts, while others offer mutual funds or access
to a full-service brokerage where you may place your money in stocks, bonds,
mutual funds, or any number of investment vehicles.
One of the biggest advantages
of retirement accounts like HSAs are that the funds are allowed to grow without
being taxed each year. This can dramatically increase your return. For example,
if you are in the 33% tax bracket, you would need a 15% return on a taxable
investment to match a tax-deferred yield of only 10%.
As another example, if you
are in a 33% tax bracket and were to invest $5,450 each year in a taxable investment
that yielded a 15% return, you would have $312,149 after 20 years. If you put
that same money in a tax-deferred investment vehicle like an HSA, you would
have $558,317 - over $240,000 more.
Because catch-up contributions
are allowed only for people age 55 and older, if one or both of you are under
age 55 you should establish your HSA in the older spouse's name. This will allow
you to capitalize on the expanded HSA contribution limits for people in this
age range and maximize your HSA contributions. Once that person turns 65 and
is no longer eligible to contribute to their HSA, you can open another health
savings account in the younger spouse's name.
Strategies
to Maximize your HSA Account Growth
If your objective is to
maximize the growth of your HSA in order to build up additional funds for your
retirement, there are three important strategies you should implement.
Strategy #1: place your
money in mutual funds or other investments that have growth potential. Though
this is riskier than placing your money in an FDIC-insured savings account,
it is the only way to really take advantage of the tax-deferred growth opportunity
that an HSA provides.
Strategy #2: delay withdrawals
from your account as long as possible. Though you may withdraw money from
your HSA tax-free at any time to pay for qualified medical expenses, you do
have the option of leaving the money in the HSA so that it continues to grow
tax-free. As long as you save your receipts, you can make medical withdrawals
from your account tax-free at any future date to reimburse yourself for medical
expenses incurred today.
As an example, let's say
a 45 year old couple places $5,450 per year in their HSA over a period of 20
years, they have $2,000 per year in qualified medical expenses, and they get
a 12% return on their investments. If they withdraw the $2,000 from their HSA
each year, they'll have a net contribution of $3,450 per year into their account,
and they'll have $248,581 in their account when they begin their retirement
years.
If on the other hand they
delay withdrawing that money, they will have $392,686 in their account at age
65. If they choose they can withdraw the $40,000 to reimburse themselves tax-free
for the medical expenses incurred during that 20 year period, and still have
$352,686 in their account - over $100,000 more than if they had withdrawn the
money each year.
Strategy #3: make the
maximum allowable deposit to your HSA at the beginning of each year. Even
though you are allowed until April 15 of the following year to make deposits
to your HSA, you should take advantage of the tax-free growth in your account
by funding it as soon as possible. The extra interest you can earn by contributing
to your account on January 1 of each year rather than the next April 15 can
amount to over $40,000 in a 20 year period, and over $100,000 in 30 years.
Using Your HSA to Pay
for Medical Expenses during Retirement
When you enroll in Medicare,
you can use your account to pay Medicare premiums, deductibles, copays, and
coinsurance under any part of Medicare. If you have retiree health benefits
through your former employer, you can also use your account to pay for your
share of retiree medical insurance premiums. The one expense you cannot use
your account for is to purchase a Medicare supplemental insurance or Medigap
policy.
Though Medicare will pay
for the majority of health expenses during retirement, there many be expenses
that Medicare will not cover. Nursing home expenses, un-conventional treatments
for terminal illnesses, and proactive health screenings are all examples of
medical expenses that will not be paid for by Medicare, but that you can pay
for from your HSA.
Long-term care is assistance
with the activities of daily living, such as dressing, bathing, or feeding yourself.
It can be provided in your home, a retirement community, or a nursing home.
Long-term care expenses can be paid for using funds from your HSA, and long-term
care insurance can even be paid for from the HSA up to the following maximum
annual amounts:
Age 40 or under: $260
Age 41 to 50: $490
Age 51 to 60: $980
Age 61 to 70: $2,600
Age 71 or over: $3,250
To establish a health savings
account, you must first own an HSA-qualified high deductible health insurance
plan. Compare HSA plans side by side to determine the best value to meet your
needs. Once you have your high deductible health insurance plan in place, you
can open your Health Savings Account with the financial institution of your
choice. About the Author By Wiley Long - President,
HSA for America.
HSA for America makes it easy to learn about and set up a health
savings account that best meets your needs. Please link to this site when
using this article.
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