Health savings accounts (HSAs) are nifty little tools that can make a big impact on retirement planning. As health care expenses continue to rise and the cost of insurance increases—these plans offer a great way to supplement retirement income and to help pay for medical expenses in your golden years.
What is a health savings account?
Health savings accounts (HSAs) are tax-sheltered plans that allow individuals and families to save money for qualified medical expenses. These plans, when used correctly, can significantly offset anticipated health care costs today and as you enter retirement. There is no set age for withdrawals—funds remain (and grow!) in the account until you need to use them. Contributions are tax-deductible, and the interest and earnings on investments grow on a tax-free basis. Distributions for qualified medical expenses are not subject to tax, either.
Additionally, there are no income limitations for participating in HSAs. You can make contributions even if you don’t have earned income. However, you cannot exceed the annual contribution limits.
Contribution limits and qualifications for health savings accounts
For 2016, individuals can deposit up to $3,350, with a $1,000 catch-up amount if you’re over the age of 55. Family plans have a limit of $6,750 and the same catch-up amount for those over 55. Employers can also contribute to HSAs, and you can request payroll reductions for your portion. The bonus? The plan follows you, wherever you go. So, if you leave an employer, there’s no hassle in moving your funds into a new account.
There are certain qualifications you must meet to participate in these accounts. You have to be covered by a high-deductible health plan and have no additional coverage except as provided per IRS Publication 969. You cannot be claimed as a dependent on another person’s income tax return, and you cannot be enrolled in Medicare.
As long as you meet these requirements, you can use HSAs to build tax-sheltered funds for medical expenses. To increase the account’s income-earning potential, a growing number of investors are self-directing their plans. By doing so, plan owners capitalize on the tax benefits and give themselves the opportunity to build additional wealth in their accounts.
Why should you self-direct your HSA?
Now we are getting to the good stuff—the part where health savings accounts can supplement your retirement income. As explained above, the main way these accounts are used is to pay for qualified medical costs. Because there is no age designation on when you can take distributions, you can save up until you need to pay for health care expenses at a later date—as in, after you retire. Holding off on distributions gives the account time to grow, which is a plus.
The real wealth-building potential comes with self-directing your health savings plan. A self-directed HSA works just like a self-directed IRA or other retirement account. As the owner, you can purchase alternative investments with funds in the account to grow income. For example, your HSA can invest in rental property in a prime location and receive steady monthly revenue that is directly deposited into the account. Your self-directed plan can also extend private mortgages and earn income on the interest rate of those loans. If you want to partner funds to acquire a more lucrative asset, your HSA can do so—it can even partner with your self-directed IRA for this purpose. And, remember, earnings grow tax-free, along with the interest the account makes. You can easily see where successful investing may lead in terms of increasing capital in your account.
Flash forward to your golden years. Distributions taken at any age for qualified medical expenses are not subject to tax, but that doesn’t mean you can’t take distributions for non-qualified purposes. You are entitled to do exactly that once you reach the age of 65, but you’ll have to pay tax at that time as you would with a typical traditional IRA.
You’re also allowed to take non-qualified distributions before you are 65. If you do, you need to clearly understand that not only will you be taxed on that withdrawal you’ll also have to pay a penalty to the tune of 20 percent.
Either way, provided your investments were solid and successful over the years, you may have amassed a substantial sum that warrants the tax and penalty. In fact, if you planned your strategy around this intention, you’re prepared to make this move. These funds now play a crucial role in financing your retirement above and beyond medical expenses.
This may sound a bit risky, but so is playing the stock market. No investment is promised to be the yellow-bricked road from rags to riches. But, self-direction allows you to control your own funds and to make your own decisions. You are able to invest in things you know and understand, which can increase your odds of success.
If you have questions regarding this article or would like to learn more about self-directed plans, please contact us.