Using your HSA to Boost Retirement Income

Thursday, August 22, 2019 |

The Health Savings Account (HSA) is a unique tool that offers a triple tax benefit not often found in financial planning. The HSA allows account owners to make tax deductible (pre-tax) contributions through a payroll deduction (much like a 401(k) contribution). Second, the investments in the HSA are allowed to grow tax-free. Third, the account owners are able to make tax-free withdrawals for qualified medical expenses.

What is a Qualified Medical Expense?

  • The IRS defines a Qualified Medical Expense (QME) in Publication 502 as a cost associated with the “diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part of the function of the body.” In summation; the expenses must be primarily to alleviate or prevent physical or mental defect or illness.
    • It might be easier to look at some common items that don’t qualify as QME’s:
      • Cosmetic surgery/alterations.
      • Funeral expenses.
      • Medicine or drugs from other countries.
      • And others found at The HSA Center website.
  • If funds are removed from the HSA before age 65 and not used on qualified medical expenses, account owners will need to pay income tax on the withdrawals and pay a 20% tax penalty.

HSA Uses for Retirement:

  • It is important to note that when you enroll in Medicare Part A/Part B you can no longer contribute pre-tax dollars to your HSA.
  • In the circumstance that a retiree reaches the age of 65 with a balance in his/her HSA, the account owner can begin making withdrawals from the account for non-healthcare related purposes and not be penalized the 20%, they would only pay the income tax due on the withdrawal, much like a retirement plan distribution. 
    • Similar to how a traditional IRA can be used as a stream of income for retirees after the age of 59 1/2, an HSA can be used in the same capacity after age 65.
  • HSA’s also don’t have a Required Minimum Distribution (RMD) schedule like Traditional IRA’s do. So allowing the HSA to continue to grow on a tax-deferred basis late into retirement might be beneficial from a retirement income and tax efficiency standpoint.

HSA Investment Allocation Strategy:

  • It’s important to keep time horizon in mind when considering how to invest your HSA account. As noted above, the HSA can be used as a dynamic tool in the retirement income plan, but we have to remember what its main purpose is; to pay for healthcare expenses.
    • With that in mind, if there is a 10% market correction and your HSA is invested in an aggressive model (90% stocks, 10% bonds) then your HSA balance will decrease in kind with the market downturn. As we know, health concerns don’t care about economic forecasts, bull markets, or bear markets. When you’re sick, you’re sick and you want to make sure the HSA is there for you to pay those QME’s.
  • In making any investment allocation decision with our clients, it always depends on a multitude of factors, but we often recommend a more balanced allocation for the HSA accounts (Often a 60/40 or 50/50 allocation).
    • With a balanced allocation, we are still planning for growth in the account, but the higher fixed income allocation can allow for reduced volatility in the short term.
The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment. The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss. When you click on any links in this document you will be connected to a third-party site. We make no representation as to the completeness or accuracy of information provided at this site. Nor are we liable for any direct or indirect technical or system issues or consequences arising out of your access to or use of this third-party site. When you access this site, you assume total responsibility and risk for the site you are visiting. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation.