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What Is An HSA And Why Is It A Strong Savings Tool?

Healthcare is among the most expensive (and vulnerable) parts of a retiree’s spending plan. The most recent study by Fidelity found that a healthy couple retiring today would spend an average of $295,000 on medical costs alone in retirement. 

If this number doesn’t make you sit up straight in your seat, this next part surely will. While that number takes into account premiums, co-pays, deductibles, and other expenses related to Medicare, it doesn’t take into account other out of pocket expenses like over-the-counter medication and most critically, long-term care. 

Genworth estimates that nearly 70% of people aged 65 and older will require some type of long-term care, which can add up easily. With the average cost of nursing care climbing to over $90,000, just one year of long-term care could quickly eat into your savings. 

How can pre-retirees better prepare for the rising cost of healthcare in retirement? An important savings tool we are going to talk about today is a health savings account (HSA). What is an HSA, and how can it impact your savings journey? Let’s find out.

What is an HSA?

A Health Savings Account is a tax-advantaged savings vehicle designed specifically for medical expenses. It helps people save up money for health-related costs. HSAs differ from other savings channels in one crucial way: taxes.

HSAs offer premium tax benefits that are helpful both in the short and long term. There are three key tax benefits this account provides:

  • Contributions are pre-tax.
  • Gains grow in the account tax-free.
  • Qualified distributions are tax-free.

When you make regular payroll contributions, you actively lower your taxable income every year you contribute. This strategy helps implement consistent and proactive tax planning strategies into your financial plan. By not having to pay taxes upon distribution, you can withdraw funds for surgery, dental procedure, or medical deductible without worrying about an additional tax burden. 

There isn’t another account quite like this. With tax benefits from beginning to end, you can start to see the appeal of investing in an HSA.

Keep in mind that for distributions to remain tax-free, they must be qualified. Qualified distributions range from prescriptions to surgeries to deductibles to medical equipment and more. But things like healthcare premiums, cosmetic surgeries, and over the counter medication aren’t qualified. 

Should you use funds from your HSA for an un-qualified medical expense, the IRS will issue a 20% penalty, and you will be responsible for paying regular income tax on the total distribution. 

So let’s say you used $1,000 for a non-qualified expense, you would have to pay a $200 penalty plus ordinary income tax. The bottom line: be sure your distributions are qualified. If you aren’t sure whether something is considered qualified or not, check in with your specific plan. 

How do you qualify?

To enroll in an HSA, you must be younger than 65, not claimed as a dependent on someone else's tax return, and enrolled in a high deductible health plan (HDHP). The IRS has rules for the type of health plan that can be considered a high deductible, and it looks at two elements: the minimum deductible and the out of pocket expense limit. 

For 2020, an HDHP must have a deductible of at least $1,400 for self coverage and $2,800 for family coverage and out of pocket expenses could be as high as $6,900 for self coverage and $13,800 for family coverage. 

These high thresholds tend to steer people away from them in favor of other health plans. But for healthy people, HDHPs are often quite affordable since they come with lower premiums. These plans do cover some preventative care services before you meet your deductibles like flu shots and annual exams. But for someone who knows their medical expenses will be high, like if you have a chronic medical condition, an HDHP might not be the best option for you.


It is vital to understand your health, current savings, and investment measures, as well as your budget to determine if an HDHP will work for you and your family. 

Why use an HSA for retirement?

This year, you can contribute up to $3,550 for self coverage and $7,100 for family coverage in your HSA. Depending on the type of plan you have, your employer may also add some funds into your account, but keep in mind their contributions count toward the annual limit. If you are over 55, you can also take advantage of catch-up contributions, which allow you to add an extra $1,000 into your account. 

Unlike another popular health savings tool, the flexible spending account funds in your HSA rollover year to year, allowing you to take advantage of long-term growth. Also, there are no required minimum distribution rules for HSAs, meaning you could hold the money in your account until you need it. Even though these are incredible benefits, many people aren’t maximizing their HSA.

The Employee Benefit Research Institute found that the average HSA balance was below $3,000, which is surprising given that the annual limit is far above that. These numbers go to show that people with HSAs aren’t actively funding them as part of a long-term plan. In addition, only 6% of HSAs maximized the investment potential in these accounts.

By taking regular distributions before retirement, many people aren’t taking advantage of the tax benefits an HSA provides. You can contribute to an HSA until you turn 65, at which point the funds can remain in the account until you need to access them. 

Thinking about an HSA as a long-term investment can help boost retirement savings while also implementing tax-efficiency strategies into your retirement plan. Taxes play such an essential role in your cash flow and income plan in retirement. Anything that you can do to make the most of the benefits available to you, our team would like to help you accomplish it. 

Be sure that you work with a professional who can help you invest your money in a way that aligns with your goals, time horizon, and risk tolerance.

An HSA and COVID-19

The novel coronavirus is a significant public health concern and has changed nearly every facet of our lives. It has brought new awareness and attention to our healthcare systems and needs as a nation. Where do HSAs fit into this?

With the current health and economic climate, the IRS has made some changes (loosening regulations) to HSAs. Most health plans, even high deductible ones, are covering the costs (copays) of medical expenses related to COVID-19. Even if your plan covers expenses before you meet your deductible, you can still contribute to your HSA. 

Under normal circumstances, this wouldn’t be the case. Providing non-preventative healthcare without a deductible, or below the minimum would make an HDHP lose its status, therefore jeopardizing HSA contributions.

The IRS is temporarily eliminating this rule to expedite testing and care for COVID-19. The rules have relaxed concerning what you can use your HSA funds for to include over-the-counter medications and feminine hygiene products. 

Invest in your health

Healthcare is an integral part of your retirement plan. With the cost of healthcare steadily increasing, it is crucial to have a firm plan in place that helps you prepare. 

Our team at Step by Step is committed to helping you prepare for every aspect of your retirement plan, and healthcare is a big part of that discussion. Are you ready to learn more about how we can help you save for medical costs in retirement? Give us a call today