Health Savings Accounts (HSAs) have been making waves in the financial world, and for good reason. These tax-advantaged accounts have seen explosive growth, with total assets reaching $116 billion in mid-2023, up from $37 billion in 2016. If you’re an HSA owner heading into retirement, you’ll want to think strategically about how to make the most of your HSA. In this article, we’ll explore the key considerations for HSA-owning retirees.
The Power of HSA Investment
For many HSA account holders, the majority of their funds are typically parked in savings accounts to cover immediate healthcare expenses. However, HSAs offer a unique triple-tax advantage: contributions are tax-deductible, earnings grow tax-free, and qualified medical expenses can be withdrawn tax-free. This makes them an attractive option for those who can afford to pay their healthcare expenses out of pocket and let their HSA assets grow.
The longer you can leave your HSA funds invested, the more they can benefit from the power of compounding. For example, if you contribute $6,000 to your HSA and earn a 5% annualized return over ten years, you could have nearly $10,000 at the end, all tax-free. In contrast, investing after-tax dollars in a taxable brokerage account would mean less money at the end due to taxes on contributions and gains.
Asset Allocation for HSA
If you plan to use your HSA for retirement, you should align your asset allocation with your time horizon. Longer time horizons allow for more aggressive investment strategies, as there’s time to ride out market fluctuations. As you approach retirement, consider a liquidation strategy based on your expected healthcare spending needs. Qualified healthcare expenses that allow for tax-free HSA withdrawals include Medicare insurance premiums (Parts B, C, and D), long-term-care insurance premiums, and out-of-pocket pharmaceutical costs, among others.
A retiree might consider holding one to two years’ worth of health expenses in the savings-account option of the HSA, another seven or so years’ worth in bonds, and the remainder in stocks. This approach aligns with the bucket strategy for managing retirement portfolios.
Where Does Your HSA Fit in the Retirement Plan?
When planning your retirement withdrawals, you’ll want to consider the order in which you access different accounts. Typically, HSAs should be accessed after taxable accounts and traditional IRAs and 401(k)s. This is because HSAs offer tax-free compounding and tax-free withdrawals for qualified healthcare expenses. Taxable accounts, on the other hand, may incur capital gains taxes and other taxes, while traditional retirement accounts are subject to ordinary income tax rates and required minimum distributions.
However, when comparing HSA withdrawals to Roth IRA withdrawals, they share some similarities. Both are tax-free and not subject to required minimum distributions (RMDs). But there’s a crucial difference when it comes to beneficiaries. If a spouse is the beneficiary of an HSA, they can maintain the account’s tax benefits. However, for non-spouse beneficiaries, the HSA’s tax benefits cease upon the original owner’s death, and the inherited amount becomes fully taxable.
For HSA owners with non-spouse beneficiaries, it’s advisable to prioritize HSA withdrawals before tapping into Roth IRAs. To make the most of your HSA’s tax advantages, carefully consider the beneficiaries of your account, potentially naming a charity as a beneficiary to avoid tax implications.
In conclusion, your HSA can be a valuable asset in retirement if managed strategically. By leveraging the tax advantages, optimizing your asset allocation, and considering beneficiary designations, you can ensure that your HSA plays a significant role in securing your financial well-being during your retirement years.
