An HSA helps cover medical expenses, but keep in mind the pitfalls

Investments and 401(k) plans are prominent in conversations about retirement planning, but one savings option that can add up quickly and prove vital post-retirement is a health savings account, or HSA.

Contributions to an employee HSA plan are made with pre-tax dollars, which provides the added perk of lowering the investor’s adjusted gross incoming as a tax-year benefit. In addition, as the HSA grows, that accumulation is tax-free, as are distributions that are made for qualifying medical expenses.

HSAs, unlike traditional retirement accounts for individuals, do not have required minimum distributions, which means that balances can continue to grow tax-free even after age 70½. HSA balances roll over and do not expire at the end of the year (unlike flexible savings accounts, or FSAs), and they’re portable if the owner decides to change jobs.

Most HSAs offer multiple options for investors, so contributions can grow faster than a common interest-bearing account.

HSA or 401(k)?

It’s not uncommon for an employee to take part in their company’s 401(k) plan and its HSA, so it’s important to know the standard differences when looking into the future and preparing for specific needs.

Traditional 401(k) plans have higher annual contribution limits, so that can allow the account to build up faster than an HSA. Employers often match 401(k) contributions, and that (essentially free) money allows the employee’s account to compound even faster.

But those same 401(k) plans also have a required minimum distribution, which means that the saver is required to start taking out funds at age 70½ regardless of whether the money is needed. That amount is based on the account’s value and an IRS calculator, and once the account withdrawals begin, they don’t stop. With the average life expectancy at 78.6 years in the United States, that can leave several years of financial uncertainty for an average individual.

On the flip side, HSAs are tax-advantageous options that can help defray costs for qualified medical expenses. These accounts have lower annual contribution limits than 401(k) plans, although they usually do not have matching employer contributions.

HSA balances don’t have an expiration date, so unused money in the account can roll over year to year. Unused, the account can build up significantly over time.

And unlike 401(k) contributions, money added to an HSA is not subject to the FICA tax of 7.65%.

Limitations of the HSA

Along with the many HSA benefits, there are limitations that shouldn’t be overlooked.

For example, there’s a 20% penalty (that’s on top of the usual income tax application) when investors under age 65 use HSA funds for non-qualifying medical expenses. Some states prohibit a state income tax deduction for HSA contributions, although that does not apply in Tennessee because the state does not have an income tax.

Some HSA accounts also include fine print that can impose inactivity fees or annual maintenance fees, which can add up over time if not addressed. There could also be fees should the investor decide to stop contributing to the plan. For example, if an investor’s current employer has a high-deductible HSA, but his or her next employer does not, that investor would no longer qualify to contribute to the HSA while they’re covered under the new employer’s health plan. In that scenario, inactivity fees and maintenance fees can add serious implications.

It’s never too late or too soon to explore options for retirement planning. Contact us at Kraft Asset Management to discuss what might be available today to help cover expenses post-retirement.

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