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Sept. 27, 2021, 4:59 a.m. EDT

The joys of a health savings account, and 5 ways you can use it in retirement

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David Conti

This article is reprinted by permission from  .

A Health Savings Account (HSA) lets you save money in a tax-advantaged account and then withdraw cash tax-free to pay for qualified medical expenses. Often, the money is used while you’re working. But you can also use your HSA in retirement to help lower your out-of-pocket medical costs then. Doing so could help stretch your retirement savings, too.

“While no one can predict what their health care costs will be in the future, we estimate that health care costs will rise 4% annually, so the numbers can get daunting pretty fast,” says Kevin Webber, a wealth adviser at Heritage Financial in Westwood, Mass. “HSAs can give clients some control over their tax bill when deciding how to pay those health-related costs.”

A definition of health savings accounts

Before explaining how best to use an HSA in retirement, a brief definition:

In 2021, you can put up to $3,600 in pretax money ($4,600 if you’re 55+ and $7,200 for a family or $8,200 for a family if you’re 55+) in an HSA. Earnings from its investments aren’t taxed; neither are withdrawals for qualified medical expenses. But to qualify for one, you must have a high-deductible health insurance plan — one with a minimum deductible of $1,400 for an individual or $2,800 for a family. (Roughly 35% of employers offer high-deductible plans, according to Bank of America. /zigman2/quotes/200894270/composite BAC +1.03% )

Before age 65, if you use HSA money for a nonqualified medical expense, you’ll owe a 20% tax penalty on the amount of your withdrawal and the money you take out for that expense will be taxed as ordinary income.

You can’t continue contributing to an HSA once you’re on Medicare; if you do, you’ll owe tax penalties.

After you die, your spouse or partner can inherit your account and turn it into their own HSA. But any money your children inherit from your HSA will be fully taxable.

Some 30 million Americans are using HSAs, says Jon Robb, senior vice president at Devenir, an HSA investment firm based in Minneapolis. Yes only 45% of people who may qualify to open an HSA have actually opened one, according to the University of Michigan’s Institute for Healthcare Policy & Innovation.

On average, HSA holders older than 50 had an average HSA balance of over $4,300 in 2020. According to Fidelity Investments, the average HSA owner holds over $8,900 in it at age 65 and $8,400 in one at 70.

Although that’s a drop in the bucket compared with the estimated $300,000 the average 65-year-old couple will need for health care, it’s a nice start.

Here are 5 ways you can use an HSA during retirement:

1. Help bridge the gap to Medicare

Say you’re 63½ and lose your job or decide to stop working before turning 65. You might not have access to retiree health coverage then, but could be able to stay on your hold employer’s plan under the federal COBRA law for up to 18 months.

If so, you could use your HSA to pay for those premiums and even health insurance premiums while receiving unemployment compensation.

“Utilizing an HSA in the pre-Medicare scenario can help save on taxes,” says Webber. “I have a number of clients using their HSAs to pay current health care expenses. This affords them the opportunity to delay tapping into their IRAs or 401(k)s to pay for medical premiums or expenses. Then, when they are in a lower tax bracket, they can convert some of their retirement savings into a Roth IRA to help reduce taxes on future withdrawals.”

Here’s an example Webber offers: “One of our clients, a software engineer, and his wife, a teacher, retired in their mid-60s and used their HSA to pay for his Medicare Part B premiums. Using the HSA was the right move because her teacher’s retirement pension was generous enough to place them in the 22% marginal tax bracket. Spending down the HSA allowed them to avoid taking IRA distributions to pay for Medicare, which would have been heavily taxed.”

2. Pay regular medical bills

Unless you’re still covered by an expensive corporate health care plan, you may be paying for vision, hearing aids and dental work from your personal savings; Medicare doesn’t cover those, but you can use your HSA money for them.

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