Another Tax-Advantaged Option for Retirement Planning
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. When it comes to saving for retirement, many investors rely heavily on tax-sheltered accounts, like 401(k)s or IRAs, but the account with the most tax advantages may actually be alongside your healthcare coverage. Joining me today to talk a little bit about how health savings accounts may be useful retirement planning tools is Christine Benz. Christine is Morningstar's director of personal finance. Christine, thanks for being here today.
Christine Benz: Susan, it's great to be here.
Dziubinski: Now, before we delve a little bit into how HSAs could be used as retirement planning tools, let's take a step back and first talk a little bit about HSAs in general and what the standard use is for them.
Benz: HSAs, health savings accounts, were originally envisioned as a way for people who are covered by high deductible healthcare plans to cover the out-of-pocket expenditures that they have. It's a tax-advantaged way for people to defray those costs as they incur them. That's the traditional use where you would use some sort of a true savings account, and you are getting three tax benefits along the way. So you're putting in pretax dollars, you're experiencing tax-free compounding, and then if you use the money for qualified healthcare expenditures, then those withdrawals will also be tax-free.
Dziubinski: Now, let's say you're using an HSA account to cover ongoing health costs. Then you're not really getting those three tax advantages. You're not getting the middle one of the tax-free compounding, right?
Benz: Right. Because chances are, if you're using an HSA in this way, as kind of a spend-as-I-go vehicle, and incidentally, that's how most people use their HSAs, the money really isn't accumulating. It's not invested in anything with much of a return, so that tax benefit that you earn there in the middle, just really doesn't add up to a significant sum for people who are using an HSA in the classic use case.
Dziubinski: Now, you've talked about using HSAs specifically to help fund long-term care in retirement. That's, of course, for people who are not needing to use that HSA on a regular basis to cover medical expenses. Let's talk a little bit about that.
Benz: Right. I think this is something that older adults in particular should think about if they are worrying about long-term care. And I talked to so many older adults who have long-term care as kind of a top-of-mind concern. You can use an HSA in really two main ways to cover long-term care. One is that you can cover your premiums, your long-term-care insurance premiums, with your HSA. The IRS sets certain limits on how much of your premium you can pay with an HSA, and it does depend on your age, so you'll need to look that up. But that's one way. If you have purchased a policy, you can use the HSA to pay those premiums. The second way would be to simply let the money grow, get it invested in some long-term assets, and then later in life, if you incur long-term care expenses, you could spend from that account to cover them. Those are really the two main ways. But I think, especially for people who are funding their HSAs pretty heavily, it's a way to think about perhaps tackling those long-term-care costs.
Dziubinski: Now, let's say you've done a great job funding your HSA, and you haven't tapped into it and you've saved it. And then you find that you actually don't have a need for those dollars--your health-related expenses aren't that great. What then?
Benz: Well, you have a couple of escape hatches. One is that if you have been paying out of pocket, if you've been using non-HSA assets to cover your healthcare costs over the years with an eye toward investing your HSA and letting it grow, the good news is that if you have documentation about those healthcare expenses that you've paid with other funds, you can use your HSA at any time, for any reason, even for nonhealthcare costs. And you can use the receipts from previous years to justify those withdrawals. And so those withdrawals would be tax-free.
Another thing to think about, though, is that if you are post-age 65, your HSA at that point becomes a lot like a traditional IRA if you use it for nonhealthcare expenditures. You have enjoyed tax-deferred compounding on your money as it has grown, but if you pull it out for nonhealthcare expenditures, the money would be taxed as ordinary income, just as it would in your traditional 401(k) or in your traditional IRA. But you've enjoyed that tax-deferred compounding, and you were able to make pretax contributions. That's another thing to think about. Those withdrawals post-age 65 aren't subject to any penalties beyond the ordinary income tax that you'd owe. I really think that investors, especially those with the wherewithal to fully fund their HSA, should think about doing so because there's just not that much of a downside.
Dziubinski: Yeah. It sounds like it really is a great tool to have in the kit when it comes to retirement planning.
Benz: It is, and especially, it's attractive to people who either have high incomes who can pay their healthcare costs separately and not leave the HSA funds, and also for people who have not a lot of healthcare costs and who really are in the best possible position to leave their HSAs undisturbed. Those are the perfect candidates for this strategy of using an HSA as a retirement savings vehicle.
Dziubinski: Well, Christine, thank you so much for your time today. We appreciate it.
Benz: Thank you, Susan.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.