When I think about retirement, I like to think about the good times I’ll be having. I think about the sports car I’ve waited to buy, the joy I hope to bring on long-term mission trips, or that vacation that has always been set aside as “someday.” What I don’t think about is “How am I going to pay for Medicare?” However, if you’re like me, we’re not thinking about the good and the bad parts of retirement, and we may be missing out on the best ways to save.
Right now, the “typical” retiree expenses related to healthcare are often as much as $500/month, $1,000/m for a couple. According to Fidelity, a couple retiring in 2018 would need an estimated $280,000 to cover healthcare costs alone. With numbers this high, we can expect healthcare related expenses to be a significant portion of our retirement. So, what can we do about it?
Using a Health Savings Account (HSA) can help us prepare for this uninspiring yet unavoidable aspect of retirement in a more effective way. Most people use HSAs as a bank account in conjunction with their High Deductible Health Plan (HDHP). They put money in at the beginning of the year, and take it out as medical expenses occur. This, however, is a shame. Unlike Flexible Spending Accounts (FSAs), HSAs do not mandate that we spend all our money or lose it at the end of each year. This opens the possibilities of over-funding the HSA and investing excess funds. HSAs receive the tax benefits of a traditional IRA in that we receive a tax deduction for our contribution, and then grow tax-free, and, if used for qualifying medical expenses, distributions are tax-free, like a Roth IRA. That is the tax advantages of both the traditional IRA and a Roth IRA, combined to make the best possible tax-advantaged account in America for qualified medical expenses.
With the benefits of HSAs being so obvious, you may be asking, “What’s the catch?” This is a fair question. HSAs were created as part of the Modernization Act of 2003, with the basic idea of incentivizing individuals both to save for medical bills and pay attention to how much they are paying. HSAs can only be contributed to in conjunction with a High Deductible Health Plan (HDHP), which requires that individuals have a minimum deductible of $1,350 (2018) or a family deductible of $2,700 (2018), and you cannot be enrolled in Medicare, other health coverage, or be claimed as someone else’s dependent. While withdrawals for qualified medical expenses are tax free, nonqualified withdrawals will count toward taxable gains and, if you are under 65 years old, will result in a 20% imposed penalty as well. Ouch!
While these penalties can be off-putting, with a little planning we can avoid the penalties and enjoy the gains. Running the numbers can be done several ways, but the preferred way to fund HSAs is concurrently with traditional retirement vehicles. If your household income is $150,000 a year and you have a desired annual retirement income of $120,000 per year, take your expected health care expenses divided by your retirement goal ($12,000/$120,000) to find what percentage of your retirement investments should be held within an HSA. In this case, 10% of retirement savings could reasonably be placed within an HSA and receive the best possible tax treatment. If the same individual was saving 15% a year for retirement, the math could look like this:
· Annual Income: $150,000
· Annual Total Retirement Savings: $22,500
· Savings Contributed to an HSA for Retirement: $2,250 (10% of yearly retirement savings)
· Savings Contributed to an HSA for Current Medical Bills: $2,700 (Covers minimum deductible for a family)
If your numbers don’t look like the ratios presented, you may want to reach out to your financial advisor to find out what else can be done. With a yearly limit of $6,900 for a family to contribute to HSAs, it can take some creativity to reach your goals, but with a little help, you can check the box on this mundane part of retirement and freely dream about the fun parts. I’ve heard that New Zealand is nice during the Michigan winters, and I have always wondered what activities they offer…
Mark VanderPol, CFP®
Disclaimer: VanderPol Investments is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.