While it is easy to daydream about retiring early, a common obstacle is saving enough to pay for health care in retirement. A 65-year-old couple can now expect to spend an estimated $260,000 on health care throughout retirement, including costs for Medicare premiums, co-payments, deductibles and prescription drugs, according to calculations by Fidelity Investments. While the premiums are likely to be deducted from your Social Security checks, you will need to come up with the cash for other out-of-pocket costs.
Health savings accounts can help you prepare for medical costs in retirement. These accounts work with a high deductible health plan, which the IRS defines as a deductible of at least $1,300 for an individual or $2,600 for a family in 2016. Here's how a HSA can help you cover health care costs.
Reduce your tax bill. Health savings accounts allow you to avoid paying income tax on money you spend on health expenses. Account contributions of up to $3,350 for individuals and $6,750 for families in 2016 are tax-deductible. And those age 55 or older can contribute an additional $1,000. The earnings and interest generated in the account are tax-deferred, and withdrawals for qualified medical expenses are tax-free. And once you reach 65, you can also use your HSA for nonmedical purposes, and the distributions will be taxed at your current tax rate.
Few restrictions. HSAs are portable and can be transferred to the custodian of your choice. While many retirement accounts are subject to required minimum distributions once you reach age 70 ½, HSAs do not have this requirement. There is also no level of income that excludes you from participating in HSAs as long as you have a qualifying high deductible health plan. You can also accumulate a balance in the account that can be used tax-free for future medical expenses.
Finding a custodian. Some employers with high deductible health plans provide a health savings account, which allows you to have your pre-tax contributions withheld from your paycheck, and sometimes companies even contribute to them on behalf of employees. If your employer doesn't provide a HSA, you need to find an appropriate custodian who can help you manage and use the account. You will want to look for a custodian who can provide easy access to pay medical expenses with a debit card and low fees and expenses for maintaining the account. Inquire about access to good long-term investments so you can grow your account without excessive costs undermining the growth opportunities. Also look for a good management interface and maybe even a mobile app so keeping up with the account will be efficient and easy.
Doing your research. The list of providers can be overwhelming, but there are research sites that will help you sort and determine the best custodian for your needs, such as HSA Search. However, before you start going through the process, you need to determine how you will be using your HSA.
If you have ongoing medical expenses that will not allow you to build up a significant long-term HSA balance, then you should focus on the custodians that have low administrative fees and also offer the best savings yield. Since your account is unlikely to accumulate a large balance, the interest earned is an important factor. There are a number of banks and credit unions that will fulfill your HSA custodial needs.
If you want to leverage the tax-advantaged structure of HSAs to build assets for future health costs, you will want to make sure you understand the investment choices available through the HSA custodian. Don't allow the mirage of low ongoing administrative expenses to lure you into a poor performing or expensive long-term investment choice. Look into the costs of the administrative platforms as well as the fees and expenses of the investments. Watch out of loads, commissions and ticket charges every time a transaction is executed. High ongoing expenses could undermine your long-term goals.
A HSA can help you to minimize taxes and save for future medical expenses, but you might need to do some research to select an appropriate account and minimize fees.
Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, "The Money-Guy Show".
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